For David Hackney and Kent Weber, portfolio managers at St. Paul, Minn.-based Advantus Capital Management, diversification is the key to gaining as many total-return opportunities as possible. And that broad-market view is what sets the company apart.
Hackney and Weber manage a total of $18 billion in equity and fixed-income assets for Advantus, a wholly-owned subsidiary of Minnesota Life, with about $3 billion in the mortgage market. The two have evolved with the market over the past 20 years, helping place capital markets assets into the mainstream.
"We've really taken an investment culture that started in the insurance business," said Hackney. "And we've been in the mortgage market - the structured market - since the late 70s, helping Wall Street structure and design and bring to market what we now know as mainstream capital-market assets."
Transactions were originally conducted as private placement deals for Advantus' in-surance company clients, and the company was one of the pioneers in various asset structures.
"Some of our people did some of the first private placement mortgage participation certificates in 1978-79," Hackney said. "We've come through the whole evolution of securitization."
Hackney and Weber have been able to use their "expertise of structure and credit" and leverage in many off-the-run sectors of the market - those asset classes that are not indexed.
A Total-Return Shop
Hackney and Weber, unlike many other retail investors, do not approach the market from an income perspective. Their portfolio is built from the bottom up, one security at a time, under- and over-weighting sectors of the mortgages market as they deem relevant.
A bulk of their portfolio - about 35% - is made up of agency passthroughs. "Those are our equivalent to Treasurys in an aggregate portfolio," Weber said. "We have an overweight in CMBS, and we have an overweight in residential credit classes, investment-grade. We're primarily an investment-grade operator." Their portfolio is also comprised of 15% in commercial mortgage-backed securities, 10% in asset-backed securities, 15% in collateralized mortgage obligations, and 25% in whole loans or non-agency mortgage product.
"So you can see, we're not a classic indexed account. We go to where we see value," Weber added.
Weber added that he and Hackney don't view mortgages as a sector, but rather as a mainstream capital market, fixed-income product, and he views his management technique as similar to corporate bond managers. "They'll do manufactured financing yankees; we'll do commercial, residential, asset-backed yankees," he said. "It's a very holistic broad-market approach."
Hackney said that vertical structuring offers more opportunities to extract value out of the market. This is one advantage he sees in pursuing this strategy in the mortgage market, which he calls one of the most inefficient sectors of the fixed-income market. "We view our style as a core-plus style, and the value is, you get broader diversification and the opportunity to garner more total-return opportunities and incremental income along the way," he said. "So we think it delivers a product that gives you more total return per unit of risk."
Culture Plays a Part
Portfolio managers at Advantus are also analysts, traders and marketing people, who are all MBAs or CFAs. Hackney and Weber meet with clients' management, actually look at the loan files and contact appraisers, delivering the information in a "consistent and disciplined manner."
Weber said that by having portfolio managers wearing many hats, they gain a lot more market color, which they pass on to their clients. "They have a very high comfort level," he said.
"To us, the mortgage market is hands-on, you have to have a hands-on approach to it," added Hackney. "We trade a lot of our own securities. And it's a contact sport. You have to get in there, and negotiate your deals, do your own underwriting."
Where Is the Market Headed?
Coming off a record-setting year, 2000 is off to a pretty rocky start, Hackney said, adding that history normally does not repeat itself in any given year. However, he does say that mortgages are looking very attractive versus Treasurys and corporates.
Hackney also said that credit should not be affecting the mortgage market as spreads widen. "The stock market has shown a lot of volatility, corporate spreads are widening," he said. "And mortgages are widening in tandem, but there really isn't - on the agency side - any credit risk fundamental."
He added that agency mortgages look as attractive now as any point in time over the last three years. "And while we anticipate a quick recovery in outperformance, I think the elements that are driving the market right now ... price discovery, inverted yield curve, buybacks, Where's the Fed going?' I don't see that curing itself any time soon," he said.
"I see the market continuing to evolve," Weber added. "[MBS] is going to become, if not the dominant force, one of the dominant forces in the market as more people realize the true size of the structured-finance market. I think it's one thing - to people who are not active in the market-are surprised at the breadth and depth of it." He also sees value in mortgages, even though over the past week, they have underperformed.
Right now, Hackney sees call-protected mortgage product looking attractive relative to those securities that carried less call protection, citing the bear market as the cause.
As for the prepayment reactions, Hackney says they will evolve over time. "We think the prepayment sensitivity in mortgages will continue to evolve and when we're pricing out credit risk or prepayment risk, we tend to want to get paid handsomely for that. And that would drive some of our relative-value determinations."
