Analyst Pick Dodge & Cox Income's Dana Emery on picking up pharma bonds at nice spreads, and the portfolio's financials and mortgage stakes.
Dan Culloton: We've heard a lot of equity investors say that the crash of 2008 presented an opportunity to buy the stocks of very, very high-quality companies at very good valuations. Companies that they would not have normally been able to buy.
Have you seen the same type of opportunities in the fixed income market?
Dana Emery: Yeah, we've definitely seen that in the fixed income market, with higher-quality names, especially pharmaceuticals. For example, Pfizer and Roche came with deals to finance acquisitions.
They had to come with a large amount of debt in a period where there wasn't a tremendous amount of liquidity in the marketplace. So they issued spreads that we hadn't seen them issuing, and were very attractive ways to add credit exposure into the portfolio at very nice valuations, without taking on significant credit risk in our opinion.
Culloton: Corporate securities have rallied pretty strongly thus far in 2009. What are valuations looking like, given the rally?
Emery: ... One measure of looking at that is looking at the differential between the yield on corporate bonds and the yield on Treasuries, or the spread of those securities is at attractive levels. Still about 200 basis points over Treasuries right now on average for investment-grade credits, and high-yield credits are even wider.
So we still think it's attractive although it's come in, as you said, tremendously from where it was ... in the fall of '08.
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Culloton: An investor looking at your portfolio would see the bonds of a lot of financial firms in there, and given the turmoil in the markets the last 18 months or two years, they might say, "Aren't they taking on more risk by investing in these financial companies which almost went bust in the crisis?"
Emery: We do have a significant percentage of the Dodge & Cox Income Fund in financials at this point, but it's a mixture of banks, systemically important banks, insurance companies, and finance companies.
So we tried to focus in during this period on looking at the ability of the companies to access the various funding programs that were created, to be able to have the liquidity that they needed to weather the downturn, and that they had adequate capital to be able to sustain their business.
So we went through a very rigorous research process to buy the securities in the first place, and then ongoing throughout the crisis, and were able to get ourselves comfortable that the investments that we're making have the staying power for the long term and offer very compelling return opportunities.
Culloton: The fund has also in recent years had a significant commitment to mortgage securities. How has that changed in the recent months?
Emery: We had a difficult decision in the fall of '08. We own only GSE mortgages, so we don't have any private-label mortgages backed by non-government-backed securities. So we have only GSEs, and we had built up the positions pretty significantly into the fall of '08.
Then in that time period we were looking at the relative value between the GSE mortgages and the credits that had widened out even more. We made the decision to reduce the mortgages, even though we still thought they were compelling, to increase the credit exposure. That's the way we funded the increase in the credit in the portfolio.
The mortgage rates have come down dramatically since the institute of these government programs. Also due to just the changes in risk premiums. So we brought down the weight commensurately with fact that you're not as rewarded as you once were to own the mortgage securities in the portfolio. But they're still a very important component of our portfolios.
