1. Lecture Presentation Software to accompany Investment Analysis and Portfolio Management Eighth Edition by Frank K. Reilly & Keith C. Brown
Chapter 19

2. Chapter 19 - Bond Portfolio Management Strategies
Questions to be answered:
What are the four major bond portfolio management strategies?
What are the two passive portfolio management strategies available?

3. Chapter 19 - Bond Portfolio Management Strategies
What are the five active bond portfolio management strategies available?
What is meant by care-plus bond management and what are some plus strategies?
What is meant by matched-funding techniques, and what are the four specific strategies available in this category?

4. Chapter 19 - Bond Portfolio Management Strategies
What are the major contingent procedure strategies that are also referred to as structured active management strategies?
What are the implications of capital market theory for those involved in bond portfolio management?

5. Chapter 19 - Bond Portfolio Management Strategies
What is the evidence on the efficient market hypothesis as it relates to bond markets?
What are the implications of efficient market studies for bond portfolio managers?

6. Alternative Bond Portfolio Strategies
1. Passive portfolio strategies
2. Active management strategies
3. Core-plus management strategy
3. Matched-funding techniques
4. Contingent procedure (structured active management)

7. 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
Indexing
The objective is to construct a portfolio of bonds that will equal the performance of a specified bond index

8. 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

9. Active Management Strategies
High-Yield Bond Research
Several investment houses such as Merrill Lynch, First Boston, Lehman Brothers, etc., have developed specialized high-yield groups that examine high-yield bond issues and monitor high-yield bond spreads
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

10. Bond Swaps Swap strategies and market-efficiency
Pure Yield Pickup Swap
Substitution Swap
Tax Swap
Swap strategies and market-efficiency
Bond swaps by their nature suggest market inefficiency

11. A Global Fixed-Income Investment Strategy
Factors to consider
The local economy in each country including the effects of domestic and international demand
The impact of total demand and domestic monetary policy on inflation and interest rates
The effect of the economy, inflation, and interest rates on the exchange rates among countries

12. 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

13. 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

14. Matched-Funding Techniques
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

15. Immunization Strategies
The process intended to eliminate interest rate risk is referred to as interest rate risk
Components of Interest Rate Risk
Price Risk
Coupon Reinvestment Risk

16. 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)

17. Classical Immunization
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

18. Matched-Funding Techniques
Horizon matching
Combination of cash-matching dedication and immunization
Important decision is the length of the horizon period

19. 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

20. Implications of Capital Market Theory and the EMH on Bond Portfolio Management
Bonds and Total Portfolio Theory
Bonds and Capital Market Theory
Bond Price Behavior in a CAPM Framework
Bond-Market Efficiency

21. The Internet Investments Online

22. End of Chapter 19
Bond Portfolio Management Strategies

23. Future topics Chapter 20
An Introduction to Derivative Markets and Securities