Decade-old municipal securities that have current call provisions, as well as attractively-priced hospital bonds affiliated with medical schools and teaching facilities, are helping one veteran portfolio manager cope with low yields and tight spreads.
Michael Pepe, at JHS Capital Advisors, is buying 10-year-old bonds that are approaching their first call date to help add income to his clients' portfolios. In addition, he is finding hospitals that are cheap in the secondary market when compared with other similarly-rated paper.
"There are no opportunities in the long end of the market in municipals like there were five years ago," Pepe said in an interview. "But we understand these opportunities can come and go, and if there is a downfall in price we have to be liquid to take advantage of it."
In the meantime, he is supplementing his clients' portfolios with bonds dated 10 years ago that are currently callable.
"They are hard to find, but they are out there," Pepe said. He prefers bonds from smaller, obscure issuers that are not as actively traded as those from larger cities and states.
For example, he recently purchased A-rated revenue bonds from Tallahassee, Fla., Memorial Health with a 6.375% coupon due in 2035 and currently callable every 30 days at $100.40 price to yield 1% and 6.30% to maturity.
The yield pick up to maturity is three points above the underlying market, Pepe said.
"If I can buy these bonds at a reasonable price with the first par call in 30 days it's all gravy from there," he said.
He noted that the yield goes up incrementally after each 30-day call at par, and the clients earn a better rate of return.
"If the bonds are called in 60 days the yield would be 3.75%," he said.
The bonds are rated Baa1 by Moody's Investors Service with a positive outlook.
"If it goes further than the 30-day call, the yield goes from 1% to 4% every time it passes the first 30 day call," he said. On Tuesday, the triple-A general obligation scale in 2045 ended at a 2.90% yield, according to Municipal Market Data.
He said the Tallahassee bonds represent one of the biggest positions in his clients' portfolios because they offer extra income.
Pepe has 32 years of experience in the financial industry and currently oversees separately-managed accounts ranging in size from $2 million to $5 million for high net worth clients, small corporations, trusts, and institutions.
His Tampa, Fla.-based asset management firm oversees $4 billion in total assets.
He said non-profit hospitals are also on his radar screen lately, especially those that are partnered with teaching facilities and medical schools and have had to conform to new funding and regulation mandates under Obamacare.
"Non profits got clobbered when Obama put out his health care plan, and those that seek funding from the federal government over-discounted the amount they were going to lose," he said.
He said he has found value in Philadelphia, Pa., Hospital & Higher Education Facilities Authority bonds on behalf of Temple University Health.
The bonds, which are affiliated with the Thomas Jefferson University Hospital medical program, are among the top performers he owns.
The 5% coupon bonds due in 2034 offer a 4.30% yield to the first call in 2017, and a 4.90% to maturity.
The Philadelphia bonds are rated Ba2 by Moody's, and BB-plus with a stable outlook by both Standard & Poor's and Fitch Ratings.
"They had their problems about three years ago, but they worked through them," he said. Generic triple-B-rated bonds due in 2034 were yielding 3.66% on Tuesday, according to the MMD benchmark scale.
New management, as well as an obligor that is aggressive when it comes to conference calls, filing financial information and other disclosures, is a selling point for Pepe.
"Temple is well connected to the facilities," he said.
"I don't look at a bond if they don't file at least quarterly reports on their financials. A lot of agencies never file, so it's like driving with a blind fold."
He also owns Hillsborough County, Fla., revenue bonds for Tampa General Hospital, which he described as "cheap to the market."
The bonds have a 5% coupon callable in 2016 at par to yield 1.42%, and 4.60% to the 2036 maturity. The yield to maturity is 160 basis points higher than comparable issues, according to Pepe.
The bonds are A-rated by Moody's and the University of South Florida's Medical School uses Tampa General as a teaching facility, which Pepe said is a selling point.
Pepe said employing these two strategies works well while he is keeping his duration short in light of the current flat yield curve and tight spreads between 10 and 30 years, and as he manages risk and remains cautious as the market anticipates higher interest rates.
He describes himself as a buy and "fold" manager - noting that when situations turn negative, he may lighten up, add to, or change position entirely to avoid volatility for his clients.
