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Lecture Presentation Software to accompany Investment Analysis and Portfolio Management Seventh Edition by Frank K. Reilly & Keith C. Brown. Chapter 20. Bond Portfolio Management Strategies. Alternative Bond Portfolio Strategies. 1. Passive portfolio strategies

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Lecture Presentation Softwareto accompanyInvestment Analysis and Portfolio ManagementSeventh Editionby Frank K. Reilly & Keith C. Brown

Chapter 20

alternative bond portfolio strategies
Alternative Bond Portfolio Strategies

1. Passive portfolio strategies

2. Active management strategies

3. Matched-funding techniques

4. Contingent procedure (structured active management)

1 passive portfolio strategies
(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 of holding 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

A laddered strategy distributes fixed income dollars throughout the yield curve.

par value


  • A barbell strategy differs from the laddered strategy in that less investment is made in the middle maturities.

par value


Classic Passive Management Strategies

  • A credit barbell is a bond portfolio containing a mix of high-grade and low-grade securities.

Classic Passive Management Strategies

Insert Figure 19-10 here.


rising interest rate falling interest rate

interest rate barbell ladder

riskfavored favored

reinvestmentbarbell ladder

rate risk favored favored

The Risk of Barbells and Ladders

  • If durationladdered portfolio > durationbarbell portfolio ,
  • Yield curve inversion means short-term rates are rising faster than long-term rates. Duration as a pure measure of interest rate risk only works for parallel shifts in the yield curve.
2 active management strategies
(2) Active Management Strategies
  • Interest-rate anticipation
    • Risky strategy relying on uncertain forecasts
    • Ladder strategy staggers maturities
    • Barbell strategy splits funds between short duration 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 to determine expected changes in its default risk

(2) Active Management Strategies

  • 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
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. Aggregate Sector 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 of achieving positive abnormal rates of return because of potential inefficiencies

Core-Plus Bond Portfolio Management
3 matched funding techniques
(3) Matched-Funding Techniques
  • Dedicated Portfolios
  • Dedication refers to bond portfolio management techniques that are used to service 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
3 matched funding techniques15
Immunization Strategies

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

(3) Matched-Funding Techniques
classical immunization
Classical Immunization
  • Immunization is neither a simple nor a passive strategy
  • An immunized portfolio requires frequent rebalancing because the modified duration of the portfolio always should be equal to the remaining time horizon (except in the case of the zero-coupon bond)
classical immunization18
Duration characteristics

Duration declines more slowly than term to maturity, assuming no change in market interest rates

Duration changes with a change in market interest rates

There is not always a parallel shift of the yield curve

Bonds with a specific duration may not be available at an acceptable price

Classical Immunization
3 matched funding techniques19
Horizon matching

Combination of cash-matching dedication and immunization

Important decision is the length of the horizon period

(3) Matched-Funding Techniques
4 contingent procedures
(4) Contingent Procedures
  • A form of structured active management
    • Constrains the manager if unsuccessful
  • Contingent immunization
    • duration of portfolio must be maintained at the horizon value
    • cushion spread is potential return below current market
    • safety margin
    • trigger point
End of Chapter 20
  • Bond Portfolio Management Strategies