All the old is new again in bonds

Unrestricted strategies for bonds is hot now so low yields.  But wait. Let's take a step back.  What we mean by a limited strategy?

A limited strategy is one that restricts the investment one can engage in either through:

Specifying a directory administrator charged with beatingSpecifying percentage limits for investments, Division by categories, such as credit quality, rate sensitivity, sub-categories for fixed (ABS, RMBS, CMBS, companies, organizations, etc.) and other variablesBarring investment in more blue fixed income instruments such as preferred stockTrust preferreds, junior debt, CDOs, RMBS, CMBS, ABS, etc. or some combination thereof.

There were no restrictions on fixed income strategies before — just not been called that.  Many value investors in the old days do not care what was the legal form of investment — just forward a sufficient safety margin.  Their portfolios were a hodgepodge of debt and equity instruments.  Specialization in only debt securities was not made public.

More investments only debt was limited, in particular those from Bank trust departments.  Of course, this was a time when investment in junk debt was respectable for all but the most intrepid investors.

With the advent of the 1980s we had two innovations: junk bonds and bond index funds.  The first took the world by storm with the requirement for performance. I have seen that at first I worked for an insurance company in junk bonds — they overloaded.  This was before the regulators regulate more strictly the bond credit quality.

The second took more time to flourish.  The first Bond Index Fund came into existence in 1986 to the forefront.  Could not call a Bond Index Fund, precisely because they could reproduce the index.  There were too many bonds that were illiquid and not buy them at any reasonable price.  On the other hand, have taken an approach that we call "enhanced indexing" now.  Match the sensitivity of the rate of the index and the credit quality, but select the bonds that had more features than the bonds in the index.

In this sense, although the Sec allows bond funds today called index funds, all funds are bond index strengthened index funds because there is no way to source all of the bonds.  And from my days as an administrator, I have learned that corporate bonds bonds in major indexes always rich trade.  By me, the education of a corporate bond Manager, part IX:

There was another example where it would cross bonds which were lawful — if this was done with the help of a broker in distress.  One day, someone gave me a rare type of capital bonds to a regular layer, and asked whether these bonds were those who were in a large bond index, without saying that per se.  After you are listed, I bought them at a level, and is called a broker, that were likely to be short bonds to see if he wanted.  He certainly did, and they are offered at three basis point concession when I bought them, unlike the copying of his daughters (such as the technical term went).

The sum of two transactions took 15 minutes, and made $ 15,000 for my client.  What was funnier, was that my entire family came to visit me on that day, my wife at the time, and seven children.  Listen to the two transactions, although we should explain them later. For the second agent, had each of the children say "Hello," ending with the then three-year-old girl that squeaked "Hello".  He said something to the effect of, ' I knew I had a big family, but only really struck me now. "

That three-year old is now a beauty in twelve, and bright as something, but I do.  (Grow fast … the nine-year old girl is cute as a button.)

Bond was just managed without restrictions other than those you're looking for total returns to the old days, and are limited to the old days by those who looked for performance.  (Many administrators will not buy bonds that are traded at a premium.)  Bond indexes then became popular as a management tool.  In a sense, bond management freed, because rather than hard constraints matched interest rate sensitivity index.

But what is limiting credit policy and interest rate policy.  Management to gain a benchmark has limited options.  What if you want to place for:

Extending credit credit spreadsNarrowing spreadsRising interest ratesFalling interest ratesYield flatteningOutperformance/curve steepeningYield curve underperfomance a particular sector

Each type of directional bets could go wrong, and more often than bonds fits into the idea of replicating the index, but is qualified in ways that do not appreciate the index.  So rather than "whole hog" gambling, simply lean towards, so if you have the wrong, it will destroy the outperformance against the index.

But in this modern world where derivatives are widely accepted as fixed-income instruments, a la Pimco, fixed-income managers can do much more.  There is more freedom to make or lose money.

The strategy without restriction can be thought of in two ways: always try to earn a positive return with high probability (T-bills is the reference point, if any), or is willing to accept equity-like variability, while the management of the bond or bonds obscure sources takes a large interest rate or credit risk.

I prefer the first idea, because it is more conservative and fixed income management should aim at average for safety.  As I said before, I only take risks that are well-compensated.

But here is a hard.  With such a large yield curve should bond Manager, with a mandate without restrictions placed a little to long bonds or long zeros?  I think so, but would not raise many exist unless the momentum started to favor it.

I like the concept of strategy of unrestricted. In fact, is what I do for clients, but it is the first variety, try to earn money for clients in all markets, and not just wild man in search of the yield or return set.

I find the transition without restriction orders to return to what is has value managers before too long, but in a more complex environment stable income.  But I wonder as to whether future failures will invalidate the idea for the most part.  It is difficult to manage any asset class while adjusting the level of risk to reflect what must not happen at a particular time, or in shares or debt.  The danger comes from trying to maintain performance levels that are higher than is sustainable.

Debt securities, macroeconomics, portfolio management, speculation, structured products and derivatives, value investing | Trackback |

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