LYCEUM-NORTHWESTERN UNIVERSITY

Tapuac District, Dagupan City

College of Business Education

Bond Portfolio
Management
Strategies

Presented By:
Michelle Q. Andres
Marypearl Navarro
Rogene Manangan
Kimberly Calaje
Almira Abalos

Presented To:
Mr. Garry Romano

Bond Portfolio Management Strategies

Bond Portfolio Management Strategies

Bond Portfolio Performance Style and Strategy

Bond Portfolio Performance

Fixed-income portfolios generally produce both less return

and less volatility than found in other asset classes (e.g.,
domestic equity, foreign equity)

shows this in the examination of the investment

performance of different long-term securities over the 21year time horizon

The low historical correlation between fixed-income and

equity securitiesReilly and Wright (2004) calculated this
to be 0.27has made bond portfolios an excellent tool for
diversifying risk

Bond Portfolio Style

The investment style of a bond portfolio can be

summarized by its two most important characteristics:
credit quality and interest rate sensitivity

The average credit quality of the portfolio can be classified

as high, medium, and low grades

The interest rate sensitivity of the bond portfolio can be

separated as short-term, intermediate-term, and long-term

Bond Portfolio Management Strategies

Bond Portfolio Strategies

Passive Portfolio Strategies

Active Management Strategies

Core-plus Management Strategy

Matched-funding Techniques

Contingent Procedure (Structured Active Management)

5 Types of Strategies
1. Passive Management Strategies
A style of management associated with mutual
and exchange-traded funds (ETF) where a fund's portfolio
mirrors a market index. Passive management is the
opposite of active management in which a fund's
manager(s) attempt to beat the market with various
investing strategies and buying/selling decisions of a
portfolio's securities.
a. Buy and Hold
- A manager selects a portfolio of bonds based on the
objectives and constraints of the client with the
intent of holding these bonds to maturity

Bond Portfolio Management Strategies

Can by modified by trading into more desirable

positions
b. Indexing
- The objective is to construct a portfolio of bonds that
-

will track the performance of a bond index

Performance analysis involves examining tracking
error for differences between portfolio performance
and index performance

2. Active Management Strategies

Active management strategies attempt to beat the market
Mostly the success or failure is going to come from the

ability to accurately forecast future interest rates

Active Strategy Attributes
Scalability
Sustainability
Risk-adjusted performance
Extreme values

a. Interest
-

Rate Anticipation
Risky strategy relying on uncertain forecasts
Ladder strategy staggers maturities
Barbell strategy splits funds between short duration

and long duration securities

b. Valuation Analysis
- The portfolio manager attempts to select bonds
based on their intrinsic value
c. Credit Analysis
- Involves detailed analysis of the bond issuer to
determine expected changes in its default risk
d. Yield Spread Analysis

Bond Portfolio Management Strategies

Assumes normal relationships exist between the

yields for bonds in alternative sectors

e. 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

Bond Swaps Types

Pure yield pickup swap

- Swapping low-coupon bonds into higher coupon
bonds
Substitution swap
- Swapping a seemingly identical bond for one that is
currently thought to be undervalued

Tax swap
-

Swap in order to manage tax liability (taxable &

munis)
Swap strategies and market-efficiency
- Bond swaps by their nature

suggest

market

inefficiency
f. Active Global Bond Investing
- An active approach

to

global

fixed-income

management must consider the following three

interrelated factors
a. The local economy in each country including the effects
of domestic and international demand
b. The impact of total demand and domestic monetary
policy on inflation and interest rates
c. The effect of the economy, inflation, and interest rates
on the exchange rates among countries
3. Core-Plus Management Strategies
- A combination of passive and active styles ( a form of
-

enhanced indexing)
A large, significant part of the portfolio is passively

managed in one of two sectors:

a. The U.S. aggregate sector, which includes mortgagebacked and asset-backed securities
b. The U.S. Government/Corporate sector alone
- The rest of the portfolio is actively managed
c. Often focused on high yield bonds, foreign bonds,
emerging market debt

Bond Portfolio Management Strategies

d. Diversification effects help to manage risks

4. Matched-Funding Strategies
a. Dedicated Portfolios
- Designing portfolios that will service liabilities
- Exact cash match
Conservative strategy, matching portfolio cash flows

to needs for cash

Useful for sinking funds and maturing principal

payments
- Dedication with reinvestment
Does not require exact cash flow match with liability

stream
Great choices, flexibility can aid in generating higher
returns with lower costs

b. Immunization Strategies
- The process is intended to eliminate interest rate risk
that includes:
Price Risk
Coupon Reinvestment Risk
- A portfolio manager (after client consultation) may
decide that the optimal strategy is to immunize the
-

portfolio from interest rate changes

The immunization techniques attempt to derive a
specified rate of return during a given investment
horizon regardless of what happens to market
interest rates

c. Classical Immunization
- Immunize a portfolio from interest rate risk by
keeping the portfolio duration equal to the
-

investment horizon
Duration strategy superior to a strategy based only a
maturity since duration considers both sources of

interest rate risk

An immunized portfolio requires frequent rebalancing
because the modified duration of the portfolio always
should be equal to the remaining time horizon

d. Difficulties in Maintaining Immunization Strategy

- Rebalancing required as duration declines more
slowly than term to maturity

Bond Portfolio Management Strategies

Modified duration changes with a change in market

interest rates
Yield curves shift

e. Horizon matching
- Combination of cash-matching dedication and
-

immunization
Important decision is the length of the horizon period
With multiple cash needs over specified time periods,
can duration-match for the time periods, while cashmatching within each time period

5. Contingent and Structured Strategies

a. Contingent procedures for managing bond portfolios are a
form of what has come to be called structured active
management
b. Contingent Immunization
- Duration of portfolio must be maintained at the
-

horizon value
Cushion spread is potential return below the current

market return
Safety margin is a portfolio value above the required

value
Trigger point refers to the minimum return that will
stop active portfolio management