Portfolio manager Dorothy Thomas is unfazed by the market's expectations for higher interest rates. She's using defensive strategies, paying keen attention to quality and limiting exposure to the longer maturities in preparation for future opportunities in a rising rate environment.
The senior vice president at Regions Investment Management
is falling back on these conservatively basic principles to deal with the challenges of low yields and tight credit spreads.
"The downside price risk on the long end is not something we want to expose most of our portfolios to," said Thomas, the head of Regions' group that oversees municipal bond portfolios for wealth management investors.
She believes owning a combination of high-grade, higher coupon bonds, short maturities, and advance refunded bonds will position her clients to take advantage of market opportunities.
"We expect this to have a future benefit in a rising rate environment," she added. "We are anticipating rates will rise even though we have been extremely low for a long time."
She said she is building a defensive posture by limiting duration just below market benchmarks, such as the Barclays five and 10-year indices.
"The municipal market has a broad duration of six years and the intermediate indices are a little less than four," she said. "We are more in line with the intermediate indices."
She prefers to participate in a range of different maturities in the intermediate slope of the yield curve, rather than restrict herself to exact years.
"The points where we find relative value may shift," depending on market conditions, she said. "There's no one place on the yield curve that we would single out as being the right place."
While she is flexible when it comes to finding relative value in the intermediate range, she said between four and 12 years "would encompass a lot of our recent activity."
Thomas declined to provide specific examples of recent trades or bonds she owns.
She also aims to build cash flow as part of her game plan to prepare for rising rates.
"We don't typically hold cash, but in a rising rate environment it's an advantage to have cash to reinvest if rates rise," she explained.
In addition, she is boosting her defensive stance by buying investment-grade paper in the midst of tight credit spreads and declining liquidity.
"That was important through the recession and the financial crisis and it continues to be important," she said. Thomas does all her own credit research, but supplements that with reports and other research available from the rating agencies and brokerage firms.
"We never relied on insurance to make credit distinctions and judgments then, and now this is even more important than a few years ago," she said, especially since she described the financial improvement among municipal issuers as "uneven."
Thomas said a move "to the other spectrum of the quality curve" would depend on the arrival of "much higher, wider credit spreads."
"With credit spreads compressed recently, sometimes it's harder to get rewarded when taking credit risk, so we are very conscious of that," she explained.
Thomas said she is also concerned and careful about rising transaction costs as they affect her clients' returns.
"When it costs a lot more to trade and absolute rates and returns are at such low levels, the valuations - the price you decide to pay or accept on a trade - plus the trading costs can make a big difference to your return," she said.
"It's something we pay a lot of attention to," she added. "It costs a lot more to trade in the market than it used to when it was more liquid and when yield and returns were at much higher levels."
Therefore, Thomas focuses on garnering the best possible total returns on an after-tax basis for her clients, who range in the size of their wealth and portfolios, but most of whom are high net worth individuals subject to the highest tax bracket.
Overall, Regions oversees the management of $9.653 billion in total assets.
By keeping her duration short, with low exposure to the long end of the curve, a focus on high-quality securities, and building cash flow, she feels she is achieving her strategy of positioning for higher rates - when and if the time comes.
"These are tools we use in other rate environments, but we have adapted them to the lower rates," she added.
"We are focusing on getting our portfolios to the point where we want them to be as rate rise," she said.
