Putnam Investments Sees "Free Lunch" in CMBS

by REIT Wrecks on August 15, 2008

This article, published yesterday in American Banker, pretty much sums it up. BBB CMBX spreads, which have been climbing throughout July and August (Markit Group Says “Bienvenido!”), are now about 2500 basis points over Treasuries, which would equate to just about a 30% (!) yield.

Despite the credit crisis—or perhaps because of it—there has never been a better time to invest in fixed-income products, particularly triple-A commercial mortgage-backed securities, according to portfolio managers at Putnam Investments.

The Boston unit of Power Financial Corp. acknowledged that advisers are facing a great deal of uncertainty and a tough economic climate that could take a long time to level off. Nevertheless, Putnam says fixed-income products, such as commercial mortgage-backed securities, municipal bonds, and high-yield bonds, remain very attractive.

Triple-A commercial mortgage-backed securities are attractive because they are protected from losses and “are the best levels we have seen in 20 years,” Bill Kohli, a Putnam fixed-income portfolio manager and team leader of portfolio construction, said in a conference call Tuesday. “This is an area that 10 to 20 years from now we are going to look back on at the historic type of values in these securities.”

The securities are “well-protected and fundamentally sound,” Mr. Kohli said. “We would need an event five to six times worse than the worst market ever before you would experience any type of fundamental loss.”

Unlike equity products, commercial mortgage securities will not be able to maintain their low prices for long, he said. “There is a massive liquidation going on today in terms of firms selling their fixed-income assets. Prices this cheap will disappear.”

These products are “plain vanilla, very liquid, relatively straightforward to analyze, and well-diversified,” Mr. Kohli said. “This is as close to a free lunch as you can get right now.”

Putnam expects a potential price return of 7% from triple-A commercial mortgage-backed securities, 7% from investment-grade bonds, and 13% from high-yield bonds.

“When you look at all of these sectors, the spreads are as attractive as we’ve seen … in our investment lifetime,” Mr. Kohli said.

Analysts and industry observers said that during a difficult economic crisis, investors are interested in using fixed-income products to shelter assets.

But W. Christopher Maxwell, a managing partner at the Rock Hall, Md., wealth management firm Conestoga Capital Advisors LLC, said that despite this notion, many investors and advisers are very suspicious of ratings right now and are wary about investing in any commercial mortgage securities, even if they have a triple-A rating.

“There are a lot of smart people out there that are trying to make astute judgments and trying to buy fixed-income products at a discount, but it can be quite difficult to find those values,” he said. “The difference between a successful triple-A-rated CBMS and one that is not so successful is not that big.”

Mr. Kohli said it is critical to maintain a well-diversified portfolio that includes a variety of fixed-income products.

“The fixed-income landscape is much more complicated than it was 10 to 20 years ago,” he said. “Companies need a certain degree of specialization to understand the dynamics. It is hard for a generalist or anyone who takes a general approach to grapple with all the issues in the fixed-income landscape.”

Putnam had $166 billion of assets under management as of June 30, including $75 billion of fixed-income assets.

Mr. Kohli said in addition to triple-A commercial mortgage securities, Putnam believes that there are opportunities to invest in high-yield bonds, municipal bonds, and even alternative-A mortgages.

Even though many analysts and industry observers have turned their back on the alt-A market, Putnam has been buying such assets over the past few weeks, he said.

“We are doing our homework,” Mr. Kohli said. “We are getting to know the underlying pools and the geographic distribution. We are not just buying plain vanilla alt-A. … We are dipping our toe in the water. We are really just starting to get involved.”

Geoffrey Bobroff, an analyst with Bobroff Consulting Inc. in East Greenwich, R.I., said that the alt-A market is a dangerous place to play right now, because it can be “difficult to distinguish the good from the bad.”

Burton Greenwald, a Philadelphia analyst with BJ Greenwald Associates, said Putnam is taking a “calculated gamble” by investing in alt-A products to stand out and improve their profile after several years of outflows caused by the poor performance of the company’s equity funds.

“Putnam has gone through more than three years of getting hit in the face every time they stick their head out of the trenches,” Mr. Greenwald said. “Their equity hasn’t shown signs of a turnaround, but they are recognized for having a strong fixed-income record. Now they want to really allow that to shine.”

Thailia Meehan, a Putnam portfolio manager and team leader of its tax-exempt strategy, said that municipal bonds remain an attractive investment option, because they are inexpensive when compared with Treasuries.

There is a tremendous buying opportunity when it comes to A-rated and triple-B-rated municipal bonds, Ms. Meehan said. A lot of investors were underweighted in municipal bonds heading into the credit cycle, she said, and this could be a good opportunity to balance a portfolio.

“This is a terrific opportunity, and we are taking advantage of it,” she said. “We are buying high-quality munis at attractive levels. We haven’t dipped down to lower-quality munis on the curve.”

Mr. Kohli said that it remains a very tumultuous economic market, and that it is difficult to make predictions, but he is confident fixed-income products will remain attractive options for advisers and investors.

“I’d love to tell you that three months from now or three weeks from now we will have the most attractive levels,” he said.

He added: “But I am comfortable saying that over a three-year or five-year horizon, the growth opportunities are phenomenal. They are off the chart.”

REIT Investments

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