Decreasing Risk, Increasing Patience with My Primus Holdings

In my last portfolio repositioning in July 2008, I first made the decision to aggressively move up in capital structure, both in terms of asset allocation and how I allocate time analyzing securities. This is a decision I have regularly revisited, but with how the macro environment has deteriorated since, my preference for debt or preferred has remained. As Mohamed El-Erian points out, government involvement invariably comes at a cost to shareholders. What he leaves out, and others have focused on, is that most government capital injections effectively subsidize an institution’s debtholders. Better to be there, in my opinion, during times of trouble.

Last week, I made my first change since July. Since then, my only investments have been in Primus Guaranty stock (PRS) and debt (PRD) – primarily the latter – and that has worked out well. In that time, I am up about 40%, while the S&P is down more than 35%. The entire time, however, the risks to the investment grade universe have grown. My estimate of a peak loss rate used for Primus’ credit default swap portfolio has risen from 1.07% to 1.52% as of the most recent quarter, and the sharp rise in the overall value of my holdings has reduced the future expected returns.