Bond management strategies are based on interest rate anticipation, sector rotation and security selection.
Interest Rate Anticipation
Strategies which involve forecasting interest rates and altering a bond portfolio to take advantage of that forecast are called "interest rate anticipation" strategies. Interest rates are the most important factor in the pricing of bonds. The price of a bond is based on its interest rate or "yield" at any particular time and the most important influence on a bond's yield is the market interest rate structure. The market interest rate for any particular term of bond is generally agreed to be represented by the yields on government bonds, as these are viewed as highly liquid and of very low default risk.
- Basic interest rate anticipation strategy involves moving between long-term government bonds and very short-term treasury bills, based on a forecast of interest rates over a certain time horizon.
- Yield curve strategies are more sophisticated interest rate anticipation strategies take into account the differences in interest rates for different terms of bonds, called the "term structure" of interest rates. A chart of the interest rates for bonds of different terms is called the "yield curve". A yield curve strategy would position a bond portfolio to profit the most from an expected change in the yield curve, based on an economic or market forecast.
Sector Rotation in Bonds
A sector rotation strategy for bonds involves varying the weights of different types of bonds held within a portfolio. An investment manager will form an opinion on the valuation of a specific sector of the bond market, based on the credit fundamental factors for that sector and relative valuations compared to historical norms and technical factors, such as supply and demand, within that sector. A manager will usually compare her portfolio to the weightings of the benchmark index that she is being compared to on a performance basis.
Security Selection for Bonds
Security selection for bonds involves fundamental and credit analysis and quantitative valuation techniques at the individual security level. Fundamental analysis of a bond considers the nature of the security and the potential cash flows attached to it. Credit analysis evaluates the likelihood that the payments will be received as contemplated, or at all. Modern quantitative techniques use statistical analysis and advanced mathematical techniques to attach values to the cash flows and assess the probabilities inherent in their nature. |