In a report released last week, analysts from JPMorgan Securities examined the relative value of hybrids to provide and alternative to seasoned agency 5/1s. Analysts noted that bottom-up money managers are still finding cheap convexity with significant upside spread potential (due to the tail) in modestly seasoned discount agency 5/1s. For instance, analysts said that slightly seasoned 5/1s offer the same - or even better - nominal spread versus comparable coupon Dwarfs after adjusting for tail value, despite 5/1s having a shorter duration and better local convexity as a discount.

JPMorgan also said that money managers who have not been so keen to go outside of the MBS Index to pick-up value are probably going to look to the most common and liquid trade first to gain hybrid Index exposure, which is evidently seasoned agency 3/1s and 5/1s. However, analysts do not expect these to tighten much further considering their historically tight valuations. They are most likely to see nominal spread tightening in new and seasoned 7/1s. The next logical reset to benefit will be seasoned 10/1s.

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