FIXED
INCOME PHILOSOPHY
We
offer separate account fixed income portfolio management. The focus
is on three areas: interest rate risk, credit quality, and client liquidity
demands. Each area has its own unique circumstances and challenges;
however, all three can be combined to form a coherent portfolio designed
to meet a client’s return objective and risk tolerance.
•
Interest Rate Risk – Interest rate risk comes in two forms.
Volatility of the portfolio and reinvestment of coupons and principal.
To address volatility, we first build a matrix of bond durations (a
measure of volatility) to determine the sensitivity of each bond portfolio
in regards to interest rate fluctuations. The final portfolio is constructed
after reviewing each client’s risk tolerance. Bond portfolios
have a very high degree of predictability, so volatility of the account
can be assumed with a high level of confidence.
•
Credit Quality – Credit quality is first addressed by buying
only investment grade bonds. Most bond positions are at least A rated
or higher. Because ratings can and do change, we diversify portfolios
to help insure against excessive portfolio risk due to bond defaults.
Bonds below investment grade are used in unique client circumstances,
but are treated as equity positions.
•
Liquidity – Some clients have unique liquidity concerns. Bond
portfolios can be structured to deal with each client circumstance.
Two basic strategies are employed to deal with liquidity requirements.
First, portfolios can be immunized. Immunization is a technique designed
to insure that a portfolio generates enough cash flow to insure all
liquidity needs are met. The strategy is based on constant monitoring
of interest rate movements, and adjusting the bond portfolio to deal
with a constantly changing interest rate environment. Finally, cash
flow matching can be employed to match interest payment dates and
bond maturity dates with specific liquidity requirements.
We
strive to add value to a fixed income portfolio by determining where
value exists on the yield curve, and then tilting the portfolio towards
the cheapest part of the curve. Upon request, a more detailed explanation
is available of the methodology used to evaluate the yield curve and
the strategies used to deal with changing interest rates.
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