A Bull Market for Agency Debt

The so-called “explicit implicit” backing of the debt of twin mortgage finance giants Fannie Mae (FNM) and Freddie Mac (FRE) has established at least one bull market in battered financials, even if equity investors continue to fret about their position in the food chain. Fixed-income investment shops are piling into the agency debt market in droves, as both the senior debt and mortgage-backed securities issued by the GSEs begin to look like a sure thing. This past weekend’s passage of a sweeping housing bill by Congress, which includes new-found authority for the Treasury to backstop both of the GSEs, has likely only strengthened the market’s position in this area. Debt issued by Fannie and Freddie has always held an implicit government guarantee. But the recent market turmoil, and passage of the aforementioned housing bill, has made that guarantee as close as it’s ever been to explicit. Yet agency debt has continued in recent weeks to offer yields at a 75-basis-point spread over Treasuries; and fund managers have clearly taken notice. One group that’s been looking to dig up the latest source of alpha for investors is the aptly-named Nomura Global Alpha, a group within Nomura Asset Management USA that lauched last July; chief investment officer Rajiv Sobti told HedgeWorld.com last week that he now sees a “unique opportunity” in agency-backed debt. “Our new fund focuses on the tremendous opportunities that exist in high-grade fixed-income in the U.S. market right now, especially in agency and triple-A securitized paper,” Sobti told HedgeWorld. The opportunity might not be all that unique, however, with Pacific Investment Management Co., T. Rowe Price Group Inc., RiverSource Institutional Advisors and U.S. Bancorp’s FAF Advisors — collectively managing more than $1 trillion — also jumping long into the agency debt market recently, according to a Monday report by Bloomberg News. “We like it,” PIMCO fund manager Bill Gross told Bloomberg. “This legislation has indicated to investors that Fannie and Freddie are not implicitly guaranteed, not explicitly guaranteed, but we’re close to that point.” The resulting bull market, however, could be surprisingly short lived — booming demand may drive yields lower on agency debt at some point, something that Nomura’s Sobti is clearly paying attention to. “If the spread over Treasuries was to reach 20 basis points, at that point we may consider shorting,” he told HedgeWorld. Disclosure: The author was long FRE when this story was published; other indirect holdings may exist, as well, via mutual fund investments. HW reporters and writers follow a strict disclosure policy, the first in the mortgage trade.