Bonds may be undervalued, but shun subprimes
— -- Q: What is "the smart" money doing regarding mortgage loans? Are some big money managers scooping up mortgage loans at depressed prices?
A: With the prices of mortgage loans in virtual freefall, the big question on Wall Street is when prices will get low enough to attract bargain hunters.
The sell-off in investments that track subprime loans has been vicious. The ABX BBB- index, which tracks subprime loans originated late in 2006, has collapsed more than 60% from mid-February, according to Markit.com. You can track the index here.
Even so, top-rated bond fund managers I've checked with are still steering clear. PIMCO's Bill Gross, said in an e-mail that he's not seeing opportunities in subprime loans. "Especially not for the average investor," he wrote.
Tad Rivelle and Bryan Whalen of the highly rated Metropolitan West family of bond funds are also steering clear of areas of the bond market that reflect lower-quality, or subprime loans. Metropolitan West was one of the first to sound the warning bell about those loans. Back in 2004, Whalen wrote a article explaining why bond buyers were underestimating the amount of risk inherent in subprime loans. You can read it here.
"We most likely haven't seen the worst of the current situation," Whalen says.
Still, there are opportunities in the bond market. Rivelle says the credit crunch and worries about the credit market have reset prices on nearly all forms of non-government debt, creating more compelling values. Investors who leveraged themselves, or aggressively used borrowed money to chase bonds and push their prices up too much, are now scrambling to sell those bonds at whatever price. That puts some good bonds on sale for investors who have been patient. "There are pockets of opportunity that will give investors credit if their horizons are sufficiently long enough," Rivelle says.
Specifically, Rivelle and Whalen see the greatest opportunities in corporate bonds issued by highly rated companies, which have been dragged down by the credit crisis. They didn't give specifics, but said bonds of financial companies were especially hammered.
Even more interesting, though, Whalen says he's intrigued by some mortgage-backed securities. Let's be clear, he's not interested in all mortgage-backed securities, but only the ones with the very highest quality. And he defines quality mortgages as those with the highest ratings, including AAA-prime mortgages, that come due in the shortest amount of time, as little as 30 days. Some of these mortgage-backed securities are yielding between 6.5% and 7.5%, Whalen says, which is very attractive given that 10-year Treasuries are yielding just 4.6%.
Plus, the mortgage-backed securities Whalen is interested in come with additional safeguards for the lenders. Typically, these securities are sold in large pools that are sliced into parts, or tranches. And they're not for individual investors. Those who own the tranches at the front of the pecking order get first dibs on all the payments received. That provides a great deal of security, Whalen says.
"Is there fundamental value in the (bond) market today?" Rivelle says. "Yes."
Matt Krantz is a financial markets reporter at USA TODAY. He answers a different reader question every weekday in his Ask Matt column at money.usatoday.com. To submit a question, e-mail Matt at mkrantz@usatoday.com.