Morgan Stanley is telling fixed-income investors to stick with mortgage-backed securities despite their poor performance in July.

In a conference call Wednesday, Morgan Stanley analysts noted that mortgage-backeds underperformed agency securities, corporate bonds, and asset-backed securities in July. Still, the analysts said that only a slight reduction in mortgage positions is warranted.

The price of mortgage-backed securities slipped about 75 basis points in July, said Joe Philips, vice president for fixed-income research at Morgan Stanley. In response the company reduced its own holdings of such securities about two weeks ago from 6% "overweight" to 4%, Mr. Philips said.

With refinancings having slowed down significantly, the supply of mortgages securities can be expected to slip, said Alec Crawford, a mortgage strategist for Morgan Stanley.

Indeed, a slowdown may already be evident in the issuance of agency pass-throughs by Fannie Mae and Freddie Mac. June's issuance, $57.5 billion, was the least since March 1998, Mr. Crawford said. Securities backed by home equity loans also remained out of favor in July as investors turned to more liquid securities, such as pass-throughs, he said.

With prepayments slowing, Morgan Stanley recommends "up-in coupon trades," which entail buying higher-coupon securities and selling the lower-coupon ones, Mr. Crawford said. Rather than sell 15-year securities, investors should buy 30-year paper, he said.

Merrill Lynch gave its fixed-income investors similar advice Wednesday, recommending they reduce their allocation to mortgages by 5% to a "modestly underweight" position. For a model portfolio, that would mean dropping the allocation to mortgages from 33% to 28%.

As an alternative, Merrill, which had been neutral on mortgage-backeds, recommended agency debt issued by Fannie Mae and Freddie Mac.

For the first six months of the year Merrill Lynch had been "heavily overweighted to mortgages," said Kenneth L. Hackel, managing director and head of mortgage-backed and asset-backed research at Morgan Stanley. But he said this strategy has changed with an increase in implied volatility in the market.

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