The following excerpt is taken from an article titled "MERUS to Boost Corporates," which appeared in the January 27, 1992,

issue of BondWeek, p.6:

MERUS Capital Management will increase the allocation to corporates in its $790 million long investment-grade fixed-income portfolio by $39.5 million over the next six months to a year, according to George Wood, managing director. MERUS will add corporates rated single A or higher in the expectation that spreads will tighten as the economy recovers and that some credits may be upgraded.

What types of active portfolio strategies is MERUS Capital Management pursuing?

MERUS is increasing corporates in it long investment-grade fixed-income portfolio in the next months to one year. They are focusing upon investment-grade securities because they expect the spread will tighten and some issues will be given higher ratings thus increasing their value. Consequently, now is the time to lock in a higher spread as well as investing in investment-grade securities that will be strengthened by a robust economy.

Given the above, MERUS is employing a yield spread strategy that involves positioning
a portfolio to capitalize on expected changes in yield spreads between sectors of the bond market. Swapping (or exchanging) one bond for another when the manager believes that the prevailing yield spread between the two bonds in the market is out of line with their historical yield spread, and that the yield spread will realign by the end of the investment horizon, are called intermarket spread swaps.

MERUS is also using a credit spread strategy. Credit or quality spreads change because of expected changes in economic prospects. Credit spreads between Treasury and non-Treasury issues widen in a declining or contracting economy and narrow during economic expansion (which is MERUS's case). The economic rationale is that in a declining or contracting economy, corporations experience a decline in revenue and reduced cash flow, making it difficult for corporate issuers to service their contractual debt obligations. To induce investors to hold
non-Treasury securities of lower-quality issuers, the yield spread relative to Treasury securities must widen. The converse is that during economic expansion and brisk economic activity, revenue and cash flow pick up, increasing the likelihood that corporate issuers will have the capacity to service their contractual debt obligations. Yield spreads between Treasury and federal agency securities will vary depending on investor expectations about the prospects that an implicit government guarantee will be honored.