Bond-Fund Giant Shows It’s Favoring High-Quality Paper

ENLARGE

Steve Rodosky

In contrast, Pimco continued to snub U.S. government debt, reducing its holdings for the ninth straight month, even though Treasurys have benefited over the past couple of months from massive safe-haven buying.

Pimco spokesman Mark Porterfield said Monday the company doesn’t comment on its bond holdings. Bill Gross, Pimco’s co-chief investment officer and manager of the $129.59 billion Total Return Fund, didn’t immediately respond to an email seeking comments on the holdings.

Over the past six months, Total Return Fund has lost about 3.4%, compared with a decline of 1.5% on its benchmark, the Lehman Brothers U.S. Aggregate Index, according to data from the company’s Web site. Still, the fund gained 3.8% over the past 12 months, beating the index’s 3.65%. Over the past five years, the fund has returned 4.3%, more than 3.9% on the benchmark.

Steve Rodosky, head of Treasury and derivatives trading at Pimco in Newport Beach, Calif. said Monday that he continues to favor agency MBS — the mortgage pass-through securities that are sold and guaranteed by government-sponsored enterprises Fannie Mae and Freddie Mac that were nationalized by the U.S. government last month — as well as agency debt. The explicit stamp from the federal government reduces credit risk, making the debt more attractive to investors.

Monday, risk premiums on agency MBS tightened amid signs of a slow revival in money markets, but earlier this month, both MBS and agency debt saw their risk premiums widen after the Treasury stepped in to backstop short-term debt sold by some major banks for a limited time and announced a plan to invest directly in banks. Investors sold agency debt and bought bonds sold by banks instead, enticed by higher yields.

But Mr. Rodosky said that despite the government backstop, there remain questions regarding bank debt offerings, including size, maturities and yield levels for new debt offerings.

There are questions to be answered before you can even make judgments about relative value, said Mr. Rodosky in a phone interview Monday. So I think you have to be patient, he added.

Until then, we are going to stick with what we know which is GSE mortgage-backed and GSE debenture papers, he said, referring to government-sponsored enterprises.

Mr. Rodosky said the government’s initiatives to tackle the financial crisis will help avoid disastrous outcomes by addressing both capital and balance sheet issues in the financial sector. The implementation of all the different initiatives will reinvigorate risk appetite, he added.

Still, he said it will take time for all the measures to work. The weakening economy may limit the upside in Treasury yields in the near term, but in the long run, Treasury yields should go up, given the erosion of flight-to-quality flows and the rising supply to accommodate increased government finance needs.

We remain underweight Treasurys. We are more interested in high quality spread paper, Mr. Rodosky said, referring to fixed-income securities that are priced at a premium to government debt.

To meet its financing requirements, the Treasury may bring back the three-year note in its refunding announcement early next month, while increasing the size and frequencies of auctions of new issues, Mr. Rodosky said. The Treasury may also consider holding more auctions for specific maturities of already existing bonds, similar to the announcement it made earlier this month to ease stress in repo markets, he said.