pp20-bond portfolio management[v1]

8/13/2019 PP20-Bond Portfolio Management[V1]

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Lecture Presentation Softwareto accompany

Investment Analys is andPort fo l io Management

Seventh Edition

byFrank K. Reilly & Keith C. Brown

Chapter 20


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Bond Portfolio Management

Strategies


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Alternative Bond Portfolio Strategies

1. Passive portfolio strategies

2. Active management strategies

3. Matched-funding techniques

4. Contingent procedure (structured active

management)


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(1) Passive Portfolio Strategies

Buy and hold

A manager selects a portfolio of bonds based on the

objectives and constraints of the client with the intent ofholding these bonds to maturity

Two prominent strategies under this approach are the

Laddered and Barbell strategies (see next six slides)

Indexing The objective is to construct a portfolio of bonds that

will equal the performance of a specified bond index


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Classic Passive Management Strategies

A laddered strategy distributes

fixed income dollars throughout

the yield curve.parva

lue

maturity

maturityparval

ue A barbell strategy differs from the

laddered strategy in that lessinvestment is made in the middle

maturities. A credit barbell is a bond portfolio containing

a mix of high-grade and low-grade securities.


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Insert Figure 19-7 here.


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If durationladdered portfolio> durationbarbell portfolio,The Risk of Barbells and Ladders

Yield curve inversion means short-term rates arerising faster than long-term rates. Duration as a

pure measure of interest rate risk only works for

parallel shifts in the yield curve.

rising interest rate falling interest rate

interest rate barbell ladder

risk favored favored

reinvestment barbell ladderrate risk favored favored


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(2) Active Management Strategies

Interest-rate anticipationRisky strategy relying on uncertain forecasts

Ladder strategy staggers maturities

Barbell strategy splits funds between shortduration and long duration securities

Valuation analysis

The portfolio manager attempts to select bonds

based on their intrinsic value Credit analysis

Involves detailed analysis of the bond issuer todetermine expected changes in its default risk


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Yield spread analysis

Assumes normal relationships exist between the

yields for bonds in alternative sectors

Bond swaps

Involve liquidating a current position and

simultaneously buying a different issue in its

place with similar attributes but having a chance

for improved return

(2) Active Management Strategies


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Core-Plus Bond Portfolio

Management This involves having a significant (core) part of

the portfolio managed passively in a widely

recognized sector such as the U.S. AggregateSector or the U.S. Government/Corporate sector.

The rest of the portfolio would be managed

actively in one or several additional plus sectors,

where it is felt that there is a higher probability ofachieving positive abnormal rates of return

because of potential inefficiencies


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(3) Matched-Funding Techniques

Dedicated Portfolios

Dedication refers to bond portfoliomanagement techniques that are used toservice a prescribed set of liabilities

Pure Cash-Matched Dedicated Portfolios

Most conservative strategy

Dedication With Reinvestment Cash flows do not have to exactly match

the liability stream


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Immunization Strategies

Components of Interest Rate Risk

Price Risk

Coupon Reinvestment Risk


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Classical Immunization

Duration characteristics

Duration declines more slowly than term to

maturity, assuming no change in market interestrates

Duration changes with a change in marketinterest rates

There is not always a parallel shift of the yieldcurve

Bonds with a specific duration may not beavailable at an acceptable price


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(3) Matched-Funding Techniques

Horizon matching

Combination of cash-matching dedication and

immunizationImportant decision is the length of the horizon

period


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(4) Contingent Procedures

A form of structured active management

Constrains the manager if unsuccessful

Contingent immunizationduration of portfolio must be maintained at the

horizon value

cushion spread is potential return below current

market

safety margin

trigger point


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End of Chapter 20

Bond Portfolio ManagementStrategies

pp20-bond portfolio management[v1]

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