Ferreting Out Income Plays
Editor's note: This is an extended version of a Q&A published in the May 5, 2008, issue of BusinessWeek magazine.
Twenty-six years ago, Thomas Atteberry switched from equities to fixed income, figuring what the field lacked in sex appeal would be made up for in job stability. In 1997 he joined First Pacific Advisors, home to the notoriously conservative—and contrarian—Bob Rodriguez. Rodriguez's FPA New Income Fund (FPNIX) rarely has sensational returns but consistently churns out around 4.5% per year. Better yet, the fund never loses money. Ever. It's currently enjoying a 23-year winning streak. Since 2004, Atteberry has served as Rodriguez's co-manager and it's his job to ensure the streak continues. He recently talked to BusinessWeek's Ben Levisohn.
Spreads on junk bonds are looking more attractive every day. Should I be scooping them up? The spread level is attractive, and the indexes look interesting. But you're in a recession and history tells us that spread and yield—the price of what you're buying—doesn't reach a floor until late in the downturn, when people sense the level of defaults peak, and the defaults haven't come about yet. Couple that with underwriting standards that were stretched and covenants in the loans that were weaker, and you realize, I don't need to be early to this.
So the economy isn't getting better any time soon? We don't believe that things are going to pick up in the second half of the year and we'll be O.K. As far as a time, we're comfortable it's not 2008. Is it 2009? Maybe.
What's holding it back? Borrowers and lenders. Consumers, who make up two-thirds of the economy, have too much debt. They're either going to spend less than they earn or sell assets to pay it down. With house prices coming down in value—for them to fall another 10% to 15%, maybe even 20%, on a national basis isn't an unreasonable expectation—consumers are not going to voluntarily sell their houses, so they'll spend less. But we're going to have delinquencies and defaults continue to be a problem because unemployment is going to rise. It will take time for the consumer to rebuild. By the same token, I'm looking at the lenders and realizing they have an impaired balance sheet. How do they make it back? They cut back on their lending, they cut expenses, they charge more to borrow, and they earn their way out of the mess. So with consumers and banks repairing their balance sheets, you look for pressure on the stock market and high yield [bonds], and for a slow recovery.
Where have you been finding bargains? We've been nibbling along at the agency mortgage space since October. As problems in the bond market have ebbed and flowed, leveraged institutions have had to sell the highest quality [loans] first—mortgages backed by Fannie Mae (FNM), Freddie Mac (FRE), and Ginnie Mae. That has diminished in size but has by no means ended. We're also finding things put up for sale in the Alt-A space [loans a step or so below prime loans]. It's a little more complex—the loans aren't quite as good quality, the underwriting wasn't very good, and you have to handicap heavier defaults. But the value is there. You have to be careful of the Midwest manufacturing areas. The Ohios and Michigans could be difficult for a long time.