R21 Fixed Income Portfolio Management - Part I

Reading 21 Fixed Income Portfolio Management – Part I www.irfanullah.co Graphs, charts, tables, examples, and figures are copyright 2014, CFA Institute Reproduced and republished with permission from CFA Institute All rights reserved Contents Introduction Framework for Fixed Income Portfolio Management Managing Funds Against a Bond Market Index Managing Funds Against Liabilities www.irfanullah.co 2 Framework for FixedIncome Portfolio Management www.irfanullah.co 3 Managing Funds Against a Bond Market Index 3.1 Classification of Strategies What type of investors might follow this strategy? 3.2 Indexing (Pure and Enhanced) 3.3 Active Strategies 3.4 Monitoring/Adjusting Portfolio and Performance Evaluation www.irfanullah.co 3.1 Classification of Strategies Passive Style: Manager has no reason to disagree with market expectations Pure Bond Indexing (or full replication approach) Enhanced Indexing by Matching Primary Risk Factors Enhanced Indexing by Small Risk Factor Mismatches Active Style: Manager believes he has superior forecasting and/or valuation skills Active Management by Larger Risk Factor Mismatches Full-blown Active Management www.irfanullah.co 3.2 Indexing (Pure and Enhanced) • Indexed funds have lower fees than actively managed accounts Why Index? • Outperforming market index consistently is difficult • Broad based index portfolios provide diversification How you select the benchmark index? www.irfanullah.co General Considerations in Selecting an Index Market value risk of portfolio and benchmark index should be comparable Given a normal yield curve and a risk-averse investor should we go with a long duration or short duration index? Income risk should be comparable Credit risk should be comparable Liability framework risk should be minimized www.irfanullah.co www.irfanullah.co Manager’s Indexed Portfolio Mimics Benchmark Bond Market Index Mimics Market of All Bonds (e.g Lehman Brothers Aggregate Index) Risk in Detail: Risk Profiles Risk profile: detailed tabulation of index’s risk exposures Changes in the yield curve represent a major source of risk for the bond market a) Parallel shift b) Twist c) Curvature More sources of risk www.irfanullah.co Exhibit 3: Typical Fixed Income Exposures www.irfanullah.co 10 ... 23 Immunization Strategies Implementation of an immunization strategy depends on the type of liabilities that the manager is trying to meet: Single Liability Multiple Liabilities (DB Plan Promised...Contents Introduction Framework for Fixed Income Portfolio Management Managing Funds Against a Bond Market Index Managing Funds Against Liabilities www.irfanullah.co 2 Framework for FixedIncome Portfolio. .. duration index? Income risk should be comparable Credit risk should be comparable Liability framework risk should be minimized www.irfanullah.co www.irfanullah.co Manager’s Indexed Portfolio Mimics