Investors who must be allocated to the government sector will be best served, he thinks, by using a laddered strategy—staggering the maturity date of bonds owned—or by investing primarily at the front end of the yield curve. Front-end securities should be able to withstand a modest rise in rates over the next year or two, he says.
The Three Cohorts
Tad Rivelle, chief investment officer for fixed income at the TCW Group, which manages approximately $145 billion in U.S. fixed-income assets, has been studying the past 25 years of economic history and won’t forecast economic growth or interest rates.
“Meaning no disrespect to those who do, I think it’s kind of a silly exercise,” he says. “I think what you’re really supposed to be focused on is recognizing where in the cycle you are.” And that, he thinks for the U.S., is the last third of its economic and credit cycle.
“You’re already seeing signs of age and you’re seeing volatility in the market, which is usually a sign that you’re relatively late cycle,” says Rivelle. “If you put a gun to our head, I think we would say that probably within 12 months you’ll probably see that the cycle is coming to an end.”
Rivelle and his team divide the fixed-income universe into three different cohorts—risk-off assets, breakable assets and bendable assets.
Risk-off assets, what investors seek when they want to avoid risk, are basically Treasurys and agency mortgages. Breakable assets are stressed and “in the event of a more generalized retrenchment in the capital markets, will adjust in price in a nonlinear, catastrophic-type fashion,” he says. Those he is currently trying to keep out of his portfolio include metals and mining companies and the exploration and production space of the energy sector.
Bendable assets, which provide yield and spread, “I think are where you actually want to be focused on in your portfolio,” says Rivelle. This includes “AAA”-rated mortgage-backed securities, auto loan securitizations and credit card securitizations, and investment-grade corporate bonds.
“For your typical large-cap investment-grade company, you’ll find that the risk premium reliably widens during periods of stress in the capital markets,” says Rivelle, “but it’s not going to go bankrupt, and the probability of restructuring is considered to be sufficiently remote.” He has recently found some value, he says, among money-center banks, REITs and utilities.