For some money managers, zero-coupon bonds are good instruments to buy as long as interest rates are falling and you need to lengthen duration.
Jeremy Ragus, portfolio manager with Scudder Kemper Investments, sees these securities more as an opportunistic trading vehicle. And the current market characteristics - narrow spreads and stable-to-flat interest rates - are not the best of conditions.
"The spreads have narrowed, they've disappeared," said Ragus, who runs the tax-exempt department at Scudder Kemper. "We used to buy them when there was a certain spread off of comparable insured bonds, and then sell them when they got narrow. But (spreads) narrowed in and stayed narrow."
Ragus is less sanguine about the value of zero-coupon bonds because of his more cautious long-term outlook for the fixed-income market in general and on municipals in particular. He sees interest rates fairly stable, and anticipates both tax-exempt issuance and demand for new offerings will be tempered this year.
"When you really get bullish, you buy zeros," he said. "Right now, I'm sort of in a neutral stance."
Like other fund managers, Ragus said he uses zeros on a "relative-value basis," only buying them if they are cheap to current coupon bonds.
At that time, "they're worth buying, because then they narrow to coupon bonds, and you can get some outperformance out of them," he said. "They're a very efficient way to buy duration when you want to extend, and you sell them when you want to shorten duration."
He also noted that zero-coupons were not suitable for all institutional investors, such as those who are focused more on distributable yield, since zeros do not have current coupons.
Ragus would not comment on the current and former positions of Scudder Kemper's zero-coupon bonds, citing company policy.
