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MANG 6222
Fixed Income Securities Analysis
Bond Portfolio Management Strategies
Dr. Yun Luo
Learning Objectives
1. The Asset Allocation Decision
2. Variety of Bond Portfolio Strategies
3. The Use of Leverage
The Asset Allocation Decision
v Public pension funds have allocations of about 2/3 in
equities (which includes real estate and private
equity) and about 1/3 in fixed income.
v Regardless of the institutional investor, there are
two important decisions to be made by an
investor/client:
v “How much should be allocated to bonds?”
v “Who should manage the funds to be allocated to
bonds?”
How Much Should Be Allocated To Bonds?
• The decision as to how much to invest in the major asset
classes is referred to as the asset allocation decision.
• The asset allocation decision must be made in light of the
investor’s investment objective.
• For institutions such as pension funds, the investment
objective is to generate sufficient cash flow from investments
to satisfy pension obligations.
• For institutions such as banks and thrifts, funds are obtained
from the issuance of certificates of deposit, short-term
money market instruments, or floating-rate notes. These
funds are then invested in loans and marketable securities.
The objective in this case is to earn a return on invested
funds that exceeds the cost of acquiring those funds.
Who Should Manage the Bond Portfolio?
• Let’s assume that an investor has made the decision to
allocate a specified amount to the fixed income sector.
• The next decision that must be made is whether that
amount will be managed by
• internal managers or
• external managers or
• by a combination of internal and external managers.
• If external managers are hired, a decision must be made
as to which asset management firm (e.g. asset
management firm) to engage.
Who Should Manage the Bond Portfolio?
• In practice, the term asset allocation is used in two
contexts.
1） The first involves allocation of funds among major asset
classes that includes bonds, equities and alternative assets.
• Although we have mentioned bonds and equities as the
major asset classes, there is now accepted a group of
assets referred to as alternative assets. For example, for
the California Public Employees Retirement System
(CalPERS), the actual (as of January 31, 2011) and target
allocation (as of June 2009) asset allocation amongst the
asset classes defined by CalPERS is shown in Exhibit 22-
1.
Exhibit 22-1 Asset Allocation of CalPERS: Actual as
of January 31, 2011, and Target Allocation as of
June 2009
Asset Class
Market Value
($ billion)
Actual
Allocation
Target
Allocation
(%)
Cash Equivalents 4.50 2.0% 2.0%
Global Fixed Income 47.50 20.8% 20.0%
AIM 32.20 14.1% 14.0%
Equity 120.30 52.8% 49.0%
Total Global Equities 152.50 66.9% 63.0%
Real Estate Global 16.60 7.3% 10.0%
Inflation Linked Global 6.80 3.0% 5.0%
Total Fund* 227.90 100.0% 100.0%
Source: http://www.calpers.ca.gov/index.jsp?bc=/investments/assets/assetallocation.xml
Who Should Manage the Bond Portfolio?
2) The second way is how the funds should be allocated
amongst the different sectors within that asset class after a
decision has been made to invest in a specified asset
class.
• In the case of equities, equities are classified by
market capitalization and by other attributes such as
growth stocks value.
• E.g. companies may be categorized as large-,
mid-, or small-cap depending on their market
capitalization.
Who Should Manage the Bond Portfolio?
• The asset allocation among the different sectors of the
bond is made at two levels.
1. The first is where a client must make a decision as
to allocate among each sector and
2. then if an external money manager is to be hired,
deciding on the asset management and amount to
be allocated to each.
Portfolio Management Team
q We refer to the person making the investment decisions
as the “manager” or “portfolio manager.”
q In practice, while there is someone who will make the
ultimate decision about the composition and therefore
risk exposure of a portfolio, that decision is the result of
recommendations and research provided by the portfolio
management team.
q At the top of the investment organization chart of the
investment group is the chief investment officer (CIO)
who is responsible for all of the portfolios.
q A chief compliance officer (CCO) monitors portfolios to
make sure that the holdings comply with the fund’s
investment guidelines and that there are no activities
conducted by the managers of the fund that are in
violation of laws or investment policies.
