John Kerschner, head of U.S. securitized products at Janus Henderson Investors, is bullish on mortgage bonds. That makes sense given that he’s also a manager of the Janus Henderson Mortgage-Backed Securities ETF.
The repayment wave that hit mortgages earlier this year amid plunging interest rates happened just as the reduction in the Federal Reserve’s holding of mortgage-backed securities increased supply. That pushed mortgage bond prices down to undervalued levels, Kerschner says. He also likes consumer asset-backed securities, thanks to the financial strength of consumers, and collateralized loan obligations.
Financial advisors still sometimes have to teach their clients the benefits of bonds—safety and income—and the limits, namely long-term returns of 3% to 5%, says Kerschner, who will speak at Informa’s Inside Fixed Income conference Nov. 12-13.
Here’s what he recently told WealthManagement.com
Wealth Management: What are the appealing opportunities in fixed income now?
John Kerschner: We like agency mortgages. It has been a bit of an unloved sector over the last few months. One-year and five-year maturities look cheap historically. Given the volatility in rates, there was a mini repayment wave, and the Fed let its mortgage portfolio run off, thus supply is heavy. So spreads have widened more than expected.
This is also a market where carry is kind. We think central banks will allow risk assets to do well, and high-risk assets will likely go into mortgages.
WM: What else is attractive?
JK: We’re still positive on CLOs (collateralized loan obligations), but higher up the capital stack: triple-A and single-A. Higher up the capital stack you have protection.
We like the consumer asset-backed market: autos and some marketplace lending, aircraft leasing. These are areas where spreads are wide, and you get cash flow back quickly.
We see the consumer sector as strong. Consumer credit is driven largely by unemployment. People will pay bills if they have jobs. As long as there’s not a deep v-shaped recession, which we think is unlikely, consumer confidence will hold up.
Of course, subprime mortgages were hurt in the financial crisis. But that was due to bad underwriting and overleverage. Subprime auto loans held up well. None of those bonds were downgraded to triple-C in 2008 to 2010. Those that did get downgraded later got upgraded and paid off fine. These are designed to perform in stressful markets too. There’s a lot of excess spread to make up for losses.
WM: What’s unattractive in fixed income?
JK: Long-dated credit, because you’re not getting compensated for that risk. Spreads are tight. There’s a bifurcation: anything that’s a solid credit in high yield is preforming well. Anything with hair on it in high yield isn’t performing well.
This doesn’t mean all corporate credit is un-investable, but you have to do bottom-up fundamental work. We like shorter-time maturities. Our crystal ball goes better for one or two years.
When it comes to leveraged loans, we agree with the headlines. You have to do your homework there to find good things.
WM: What do you think about the choice between individual bonds, ETFs and mutual funds?
JK: Retail investors have difficulties with individual bonds. People don’t know them well. Usually knowing that prices go up when interest rates fall is as far as it goes. Most people invest for safety and income. Trying to do that with individual bonds is very difficult for investors. Execution alone is problematic.
You can buy an [actively managed] ETF with good management at a reasonable price. We believe in active management for fixed income, because there are a lot of inefficiencies in the space, particularly mortgage-backed securities. We’re the first active MBS ETF. We think we can outperform by 30 to 50 basis points, compared with passive funds, which underperform by 15 to 20 basis points.
Individuals shouldn’t try to do it alone. There are good mutual funds and ETFs. You have to look at fees. In fixed income, it’s much easier to beat benchmarks than in equity. The main bond market index—the Bloomberg Barclays Agg—excludes a vast amount of the market. You don’t get much yield with the index, but you get interest rate risk.
WM: What do you see as the role of financial advisors with clients looking for income?
JK: Of course they want to figure out clients’ savings goals and risk tolerance. Most investors are saving for different things in different parts of their lives. In your 20s and 30s, it may be a house. In your 30s and 40s, it may be college for your kids. In your 50s and 60s, it may be retirement. You’re never really saving long term, mostly five to 10 years out. And for any of those pools, fixed income makes sense.
Educate your clients. Let them know that bonds give you income and safety. Make sure clients understand the role of fixed income in their portfolios. Investments should never make you rich and wealthy. What you do in your day job earns you the money you have. Investing is more about trying to grow your money.
And financial advisors’ role is to get people realistic about long-term returns: 6% to 8% overall and 3% to 5% for bonds. If your clients accept that and invest for the long term, they will have a good nest egg.
