A sector rotation strategy for bonds involves varying the allocation or
percentage "weights" of different types of bonds held within a
portfolio.
An investment manager will form an opinion of the valuation of a specific
sector of the bond market, based on the credit fundamental factors for that
area, 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 or "bogey" that she
is being compared to on a performance basis.
For example, a Canadian bond manager might feel that provincial bonds are
historically cheap compared to federal government bonds. The manager would run a
historical comparison of the difference in interest rates or "yield spread"
between various terms of provincial and Canada bonds and compare these levels to
historical norms. If the interest rate on provincial bonds was relatively high
compared to historical levels, the manager would consider them to be "cheap".
The manager would then consider the fundamental factors, such as tax revenues,
budgetary issues and even political developments and then "overweight"
provincials versus their index weight. She would also take into account
technical issues such as prospective new issues and the financing requirements
of the provincial governments. The demand for provincial bonds would also be
important, as they are high quality and higher yielding investments for
financial institutions such as insurance companies and banks. If their preferred
investment such as mortgages and commercial loans are in short supply, they will
use substitutes such as provincial bonds. This same technique is used to
allocate weightings in the portfolio between other types of bonds such as
corporates, municipals and asset-backed securities. |
