MNI: Portfolios: Baird: Gradually Cut Risk, Shorter on Curve

By Yali N'Diaye

     OTTAWA (MNI) - With no U.S. recession in sight but growth in its late

innings, Baird Advisors continues to favor corporates, but is gradually moving

up the credit quality ladder and down the maturity spectrum.

     While looking for higher-rated securities, "we are trying at the same time

to take our credit exposure a little shorter on the yield curve," Senior

Portfolio Manager Duane McAllister told MNI.

     Still, in his view, the lower-for-longer interest rate theme could stretch

more than investors expect and there is no reason to rush the positioning

adjustment. 

     Fixed income flows have shown that money is coming into the short end of

the yield curve, with limited duration or interest rate risk, he said. But

investors could be disappointed by expecting higher rates and staying shorter in

their overall allocation duration than what they should have done.

     While data remain supportive of further Federal Reserve rate hikes, with

one more likely by the end of this year, the terminal Fed funds rate target

range for the current cycle could be as low as 1.75%-2.0% once the central bank

is done raising rates, he said.

     On the balance sheet front, McAllister expects a "very gradual" path

leading to higher interest rates as the Fed allows Treasuries to roll out, and

to wider spreads on agency mortgage-backed securities. 

     Against this backdrop, the asset manager feels comfortable with credit,

citing positive technicals and fundamentals, and favoring financials, given that

post-crisis reforms have reinforced banks' balance sheets, especially their

capital position, a positive from a credit profile standpoint.

     On the demand side, he cited ongoing steady and "very strong" demand for

fixed income assets, as reflected in mutual fund flows.

He also sees anecdotal evidence from insurance companies, pension funds and

asset managers who have a need for balancing their liabilities with assets,

creating demand for longer-term fixed income assets.

     On the supply side, net corporate and muni bond supply year-to-date is

lagging behind 2016, and in light of the Trump administration's difficulties in

implementing campaign promises, it doesn't look like there will be any major

infrastructure plan anytime soon that would boost muni supply in the near term.

When looking at fundamentals, while the lower-for-longer environment is in the

late innings of the ball game, McAllister believes it can still stretch out for

a "period of time". 

     And any tax reform, if enacted, could help extend the cycle.

     At the minimum, the portfolio manager sees no sign of a recession,

estimating that house prices are not excessively overvalued, individual balance

sheets have much improved despite concerns over student loans, and that

fundamentals for corporations are "pretty good", as is employment.

     As a result, the Baird portfolio manager sees corporates as the way to go,

and investment grade as the needed additional safety given that U.S. growth

expansion is in its later stage. That being said, with still potential for

growth to continue, perhaps matching the record streak of 120 months, which

would leave about two more years to go, he is not rushing to move to the shorter

part of the yield curve.

--MNI Ottawa Bureau; +1 613 869-0916; email: yali.ndiaye@marketnews.com

[TOPICS: M$C$$$,M$$FI$]