Total income method
Total income method is the most commonly used asset management method and an investment strategy to maximize the total income of portfolio. The two components of the total rate of return are income and capital gains. Although these two components of the total return have different risks, they are interchangeable in the total return method. Like stocks, the total yield strategy of bonds is also based on its own risk factors. In the total rate of return method, the total rate of return of fixed-income portfolio is compared with the total rate of return selected as the benchmark for portfolio evaluation (discussed in more detail below). The risk coefficient of the benchmark should be similar to that of the bond portfolio. But generally speaking, two different portfolios, or a portfolio with different risk coefficients and a benchmark, will show different total returns for the same market change. The portfolio manager should calculate or measure the risk coefficient in advance, or understand the different reactions to the relevant market changes, or change the risk exposure of the risk coefficient through portfolio measures when the portfolio manager cannot accept such reactions.
Therefore, the change of market behavior will have different effects on the performance of asset portfolio and benchmark because of its different risk factors. It is very important to measure the risk factors of portfolio and benchmark in detail in comparing the performance of portfolio and benchmark due to market changes. This is why the risk coefficient of bond portfolio should be very similar to its benchmark. The specific method of doing this will be described in Chapter 9. After selecting the benchmark, realizing the risk factors of the portfolio and calculating the risk factors of the benchmark, the portfolio manager must decide whether the portfolio should copy the risk factors of the benchmark or deviate from the benchmark. The investment strategy of copying all risk factors is called passive strategy; An investment strategy in which one or more risk factors deviate from the benchmark is called an active strategy.
In other words, portfolio managers can adopt passive strategies for some risk factors and active strategies for others (considering the variety of risk factors, there will be many strategic combinations). Passive strategy does not need to predict future market changes, because portfolio and benchmark respond to market changes exactly the same. Active strategies are based on forecasts, because portfolios and benchmarks react differently to market changes. In the active strategy, the portfolio manager must decide the direction and degree of the risk factor value of the portfolio deviating from the benchmark risk factor value according to the expected market changes. Therefore, under the condition of multiple risk factors, there will be both pure passive strategies and mixed strategies that are passive in some risk factors and active in others.
Chart 1-2 summarizes passive strategies and some common active strategies. Active strategy involves various risk factors of fixed income. An active fixed-income bond manager may be positive about any combination or all of these risk factors. This chapter does not discuss any of these strategies comprehensively, but makes stylized comments on some common strategies.
1. Market time selection
Few institutions will change the term of portfolio according to their own views on the change of return rate, so as to implement market timing. No one can predict interest rates with confidence and reliability. The general view is that the risk of increasing the portfolio by market timing method is far greater than the increased income, and the yield of incremental portfolio is often negative. However, due to the influence of the change of yield on the maturity of fixed-income securities that can be redeemed or repaid in advance, the maturity of its portfolio will change inadvertently due to the change of yield, although continuous monitoring and adjustment may reduce this influence.
2. Credit risk allocation
Institutions often change the average credit risk of their corporate bond portfolio according to their views on the credit yield curve (that is, the spread between high-grade and low-grade yields expands or narrows). For example, if they think the economy will be weak, they will upgrade their investment portfolio.
3. Departmental rotation
Colleges and universities can rotate departments, such as finance to industry, according to the current evaluation of departments and their expected economic strength.
4. Securities/bonds selection
Most active institutional investors will have internal credit or basic bond researchers to analyze individual bonds to assess whether their value is overvalued or undervalued. If portfolio managers avoid WorldCom in June 2002 (when WorldCom held the largest weight in Lehman Composite Index) or before GM or Ford were downgraded to junk bonds in June 2005, they would benefit greatly. The choice of securities/bonds can also be based on the expensive/cheap strategy (including long-short strategy) of national debt, mortgage-backed securities or other fixed-income bonds.
5. Core-subsidiary asset allocation method
As shown above, active/passive decision-making is not binary. The passive method means copying all the risk factors, while the active method can have multiple subsets by actively adopting different combinations of risk factors. There is another way to show that the active/passive method is not binary. An overall fixed-income portfolio may be composed of several specific types of fixed-income assets. The manager of the whole portfolio may choose a passive method, which is considered to be very effective and unlikely to produce alpha in some asset types. Other asset types may be considered less efficient because they are more special and more likely to generate alpha.
For example, portfolio managers may choose to adopt a "core" portfolio of US investment-grade bonds passively managed through Lehman Composite Index, and a "satellite" portfolio of actively managed bonds such as US high-yield bonds and emerging market bonds. This kind of core subsidiary law is very common among institutional investors. These fixed income investment strategies and other strategies are commonly used by institutional investors. However, please note that the total rate of return method is related to external benchmarks and does not involve internal liabilities or products. This is why the total return method is very similar to bonds and stocks. Now let's consider the evaluation of an institution's portfolio relative to its own liabilities or products. Because the cash flow of these liabilities or products is more similar to bonds than stocks, bond investment strategies play different roles in this situation.
Debt financing mode
The benchmark of the total return method is the external average fixed rate of return. Now let's consider benchmarks based on internal liabilities or products. Examples of this can be the payment of pensions with defined benefit plans, death benefits determined by actuarial life insurance companies, or the payment of fixed-interest deposit (CD) accounts in commercial banks. In each case, the repayment of liabilities can be modeled as cash outflow. This fixed cash outflow can be financed by bonds that can provide known cash outflows, and small ones can be provided by stocks with unknown cash outflows. Let's consider the bond investment strategy to provide financing for such liabilities. The first strategy is to build a fixed-income portfolio with the same maturity as the cash flow of liabilities. This strategy is called risk immunization strategy.
In fact, only when the yield curve moves in parallel will the risk immune portfolio match the liabilities in terms of market risk. However, if the yield curve becomes steep (flat), the performance of risk immune portfolio will be worse (better) than the cash flow of liabilities. A more accurate way to match the cash flow of these liabilities is to build a portfolio with exactly the same cash flow and liabilities. This method is called special portfolio strategy. The implementation of special portfolio strategy is more restricted than the implementation of risk immune portfolio strategy, so the rate of return is also lower. However, the effectiveness of special portfolio strategy is not affected by the change of yield curve slope. However, if the portfolio contains non-treasury securities, this strategy has the same credit risk as the risk immunization strategy.
To some extent, the simplified special strategy combination is called ladder combination. It is often used as a retirement plan by individual investors. Suppose a 60-year-old investor has $900,000 for retirement, plans to retire at the age of 65, and hopes to have funds in the next 65,438+00 years. Investors can buy zero coupon bond (face value or maturity value) with maturities of 5 years, 6 years and 7 years 14 years, each with $65,438+million. In this way, investors will not be affected by the change of yield and yield curve in the next 10 year, and there will be 65438+ million dollars of funds every year. In order to continue this method after the age of 75, investors can buy ~ new 10-year bonds after the maturity of each bond. Of course, these subsequent investments depend on the rate of return at that time. This series of bonds with different maturities, 13, will gradually mature over time, which is a trapezoidal combination (some analysts compare the trapezoidal combination to a stock strategy, which is called dollar cost averaging).
The cash flow income of 10 is a self-made deferred fixed annuity. If cash flow starts immediately, it is a spot fixed annuity. A simpler strategy is called income spread management, or simply spread management. Suppose a commercial bank issues a six-month certificate of deposit, or an insurance company underwrites a six-month guaranteed investment contract, the profitability of these instruments (regardless of the option nature of GIC) will depend on the difference between the return on assets invested in these products (such as six-month commercial paper or six-month fixed interest rate paper) and the return paid by the institution on these products. Interest spread management is to fund these products according to the accounts invested in assets to manage the profitability of assets. In the short term, if the assets used are low-grade, their profitability will be higher, but in a longer period, the profitability of assets may be reduced due to default. In short, when both bonds and stocks can use the total return strategy, only bonds are suitable for many debt financing strategies, because bonds have a fixed cash flow according to face value and maturity value.
Unified method
Recently, there is a method to consider risk and corresponding income, which is to divide risk and corresponding income into three components. Litterman called this method "active alpha investment method".
The first type of risk/return is the risk and expected return generated by the liabilities of institutions or individuals. Design a portfolio that matches institutional liabilities, and its income will match or exceed the cost of liabilities. Generally speaking, liabilities are bonds, so the matching portfolio is generally a fixed-income bond portfolio. For example, the investment portfolio matched with fixed pension, whole life insurance insurance policy and floating rate loans from commercial banks.
The second type of risk/return is a portfolio that provides market risk, that is, either the stock market risk (measured by beta coefficient) or the bond market risk (measured by duration). The return of this portfolio is the stock market return (corresponding to the beta obtained) or the bond market return (corresponding to the duration obtained). The market risk portfolio can also be a beta portfolio of stocks and a duration portfolio of bonds, rather than a pure beta portfolio or duration portfolio, that is, a market risk asset allocation. In operation, beta portfolio generally obtains beta coefficient equal to 1 through S&P 500 products (futures, swaps, etc.). ), and the duration of the long-term portfolio is equal to Lehman composite index products (futures, swaps, etc.). ). These beta coefficients or durations can also be changed at these benchmark levels through additional (long-term or short-term) derivatives.
The third type of risk/return is the alpha portfolio (or active venture portfolio. Alpha is the return of portfolio adjusted according to market risk, that is, the return adjusted according to risk or excess return. The risk factor model is becoming more and more complex to adjust other risk factors (such as two-factor, three-factor and four-factor alpha) that determine alpha besides market risk. Now, let's assume that on the one hand, it is beta or long-term income, on the other hand, it is alpha income, which plays a role in a single stock portfolio or a single bond portfolio, that is, by choosing a passive (or indexed) portfolio, in which the market income of stocks is the income of Standard & Poor's 500 and the market income of bonds is the income of Lehman Aggregate Index, we can only get the beta income or the duration of bond income in the stock market. By choosing a positive stock portfolio, we can get both the beta coefficient of the stock market and a positive or negative alpha coefficient. Positive fixed income funds, bond market duration and alpha income are similar.