In these shaky times, many investors and asset-management shops dabbling in the securitization markets have tightened up on credit, targeting higher quality, top-tier, often none-too-exciting assets.
Still, there are pockets of high-quality value to be found if you know where to look, according to Thomas Sontag, portfolio manager in charge of ABS and MBS at Milwaukee-based Strong Capital Management. For example, Strong, which is currently shopping in cautious mode, has found juice in secondary CDO paper, a market in the initial stages of development.
"And I'm not talking about the triple-A's on deals that are blowing up," Sontag said. "Even for the highest rated classes [of CDOs], it appears to me that you can buy much cheaper paper in the secondary market than you can in the primary market, even in deals that are performing average for that vintage."
However, in the ABS/MBS arena, Strong usually treads in tested waters, such as fixed-rate MBS, CMBS floaters and shorter duration, commodity ABS. The firm, which has been actively investing in securitized products since 1990, manages about $4 billion in ABS and MBS, which includes approximately $250 million in CDOs, Sontag said.
Mutual fund family
Strong Capital, established in 1974, is a money manager with products ranging from mutual funds to private and preferred client investment programs. Additionally, out of its high yield group, Strong issues CDOs. The firm currently holds approximately $42 billion in assets under management, about 50% of which are in fixed-income securities, the other half in equities. According to the company, it's ranked as the 35th largest mutual fund family, in terms of assets under management, out of more than 660 mutual fund firms.
Sontag has been with Strong since 1998, and prior to that was a managing director in fixed-income mortgage sales at Bear Stearns, where he had been for 13 years.
The CDOs and ABS that Sontag buys are generally placed in the firm's Advantage Fund, which is the cash management, 0.5-year to one-year duration assets, and a short-term bond fund, which targets two-year duration assets.
"For those two funds we use a fair amount of asset-backed securities and floating-rate commercial mortgage-backed securities, because of the short duration nature of those assets," Sontag said.
As for CDOs, Strong typically buys floating-rate paper, in the top-tier of the capital structure, either double-A or triple-A-rated. Further, the firm has primarily been an investor in the straight high-yield CDOs with no emerging market exposure, although Strong has bought into a limited number of multi-asset, ABS/MBS-backed deals.
"In CDOs, we don't do a whole lot that's real interesting," Sontag said. "Fortunately, given what's going on out there, we've stayed away from a lot of the lower rated classes."
In CMBS however, Sontag is willing to buy down the credit spectrum, all the way to the triple-B level, though mostly in the single-A area.
"The [CMBS] market in general has seen more upgrades than downgrades," he said.
ABS consumer exposure
In the past, Strong has bought everything from autos and credit card floaters to rate-reduction bonds and tax-lien securitizations. Lately though, the firm has tended away from one-off, untested transactions, such as the recent tobacco litigation-backed bonds.
That's because the firm is skeptical about the economy and consumer credit, particularly subprime. For that reason, Strong is tending to stay in the higher quality, higher rated assets for the near term.
"I would think our overall theme right now is that we're up in quality, higher than where we typically would be," Sontag said. "When we think the economy's coming back, and that the consumer is on strong footing ... we would look down the credit spectrum, in home-equity loan deals, credit card deals, auto deals, really in any of the classes. There's a fair amount of correlation in those classes. Because if you think about it, the end credit for all these asset-types is the American consumer."
As for mortgage-backeds, Strong is currently positive on passthroughs, although that's not always the case. Typically, the firm will buy mortgage product with better-than-average prepayment protection, like straight conduit, ten-year triple-A CMBS or Fannie Mae delegated underwriting and servicing (DUS) paper.
"These securities have prepayment protection built into the deals, whether it be yield maintenance, or strict lockout on prepayment of loans," Sontag said.
On top of that, Strong spends a fair amount of time analyzing individual pools. For example, the firm is currently looking at the super-seasoned premium part of the market, such as residential mortgage loans at 9% coupon, that have been outstanding since the mid-80s, where it's pretty clear the borrowers are not likely to refinance.
"Typically, we underweight straight passthroughs, which are the most sensitive to refinancing opportunities," Sontag said. "Lately, however, we have increased our exposure to straight passthroughs, particularly 15-years. We think they're good value, with the curve as steep as it is. We think there's going to be good demand by financial institutions."
