US fixed income fund managers continue to see value in the credit markets as a whole, although parts of it are deemed expensive, says S&P Capital IQ's Fund Research in its latest sector trends paper.
"Most of the fund managers we interviewed were overweight spread product relative to their indices, but this is a structural feature of the US fixed income fund sector, particularly for funds managed against aggregate indices," observed Kate Hollis, S&P Capital IQ fund analyst and sector head of fixed income.
Many managers were overweight financials, which were still yielding more than industrials, and many (such as Pioneer) were aiming to move up in credit quality where this was possible without sacrificing too much yield. Many investment grade funds had bought small amounts of crossover high yield names, to produce extra yield and increase the potential for spread tightening should they be upgraded.
Corporate balance sheets are strong, as are earnings, and default rates are likely to stay low. Technicals are still supportive and BlackRock noted that any sell-off in credit markets would be met with further buying; at the short end from investors looking to switch out of cash, and at the long end from pension funds.
Managers believe spreads are still likely to shrink in 2013 but most of the return will come from income. However, MFS Investment Management pointed out that some industrials are back to the same spreads as in 2006. AllianceBernstein agreed that valuations are tight but that carry and roll-down will continue to add extra return until the long end of the Treasury market begins to back up.
Meanwhile, a large leveraged buyout (LBO) of Dell has sparked credit analysts to review their sectors for other potential buyout candidates.
Many groups were overweight agency mortgage-backed securities (MBS) as they believe the Fed will keep prices supported to avoid any rise in mortgage rates slowing the housing market again. Although agency pass-throughs are negative convexity instruments, most managers believe any rise in volatility this year will be associated with politics and will be temporary. Many managers also had small amounts of commercial mortgage-backed securities (CMBS) on which they were starting to take profits. However, T Rowe Price is letting its MBS positions diminish naturally and reinvesting in asset-backed securities to reduce the pre-payment risk.