Fixed Income Insights
Many investors can be intimidated about investing in the fixed income markets because fixed income investing is a large, complex, multi-dimensional math problem. There are fixed and floating rate coupons, maturities from one day to 100 years, many different types of “yield,” as well as different types of call features. There are credit ratings, credit spreads, yield ratios, not to mention that, for taxable investors, your own tax profile can drive which type of bond you should invest in since different types of bonds may be taxed (or not) at the federal, state, and local levels.
In short, there is a significant amount of detail that needs to be evaluated and factored in when making an investment decision. The challenge for many investors is quantifying the often conflicting investment objectives of income generation and asset price stability. Employing an analytical (mathematical) approach assists in quantifying the risks and rewards in the market when it comes to interest rates and credit quality.
In this complex nebula, SCM’s philosophy is that a mathematically logical and reasoned approach to fixed income investing serves to cut through the haze and hype and leads to a thoughtful result.
There are many types of quantitative analysis, and no single one covers all aspects of investing. Three types of quantitative analysis provide guidance for yield curve positioning and asset class selection:
Interest rates, economic conditions, issuer credit quality, tax rates, currency values – and, therefore, the relative value of fixed income asset classes – all are subject to change. The supply of new bond issues waxes and wanes and market-changing events occur, as do personal life events and changes in residence; these are all front-page and commonplace events that can prompt an advantageous adjustment to a portfolio.
Taking a buy-and-hold approach has the potential to negatively impact a portfolio due to lack of attention. On the other hand, actively trading a fixed income portfolio, particularly for a taxable investor, also may have potentially negative consequences related to excessive transactions costs, tax inefficiency, and “whip-sawing” during fast-moving markets. There is a point in the middle, an equilibrium “buy-and-manage” approach, where portfolios are adjusted due to aging, a modification of market view, or change in personal circumstance.
The debate regarding buy-and-hold investment strategies versus active management will never end, because neither method has the right answers for all investors and asset classes. The optimal approach for many investors may very well be a combination of managed and transactional based upon the strategies, vehicles, and asset class mix.
Investor-specific circumstances may give one method greater appeal than the other. The choice should depend upon: 1) investment objectives, 2) asset class, 3) the rate of asset turnover, 4) the average maturity of the portfolio, 5) commission rates, 6) the amount of management fee charged, 7) legal liability considerations, and 8) the desire/ability of the investor to be meaningfully involved in the management process of the portfolio.
We believe that for most investors, considerations 7 and 8 are most important.
When considering item 7, do you as a guardian, trustee, or public official want to take personal responsibility for each and every transaction or outsource that responsibility to a portfolio manager? Item 8 expands upon item 7, asking if the person responsible for investments has the desire/ability to be meaningfully involved in the management process.
Finally, we believe investors are best served by finding a highly skilled and knowledgeable fixed income professional with a high information ratio and extensive portfolio management experience. We believe Stifel Capital Management meets and exceeds those requirements, and we stand ready to assist you with your fixed income portfolio needs.
In short, there is a significant amount of detail that needs to be evaluated and factored in when making an investment decision. The challenge for many investors is quantifying the often conflicting investment objectives of income generation and asset price stability. Employing an analytical (mathematical) approach assists in quantifying the risks and rewards in the market when it comes to interest rates and credit quality.
In this complex nebula, SCM’s philosophy is that a mathematically logical and reasoned approach to fixed income investing serves to cut through the haze and hype and leads to a thoughtful result.
There are many types of quantitative analysis, and no single one covers all aspects of investing. Three types of quantitative analysis provide guidance for yield curve positioning and asset class selection:
- Interest rate horizon analysis is a forward look at what the potential results could be if interest rates move higher and lower over the next one to four years. By measuring the combined effects of cash flow generation and change in market value over time, an investor can obtain greater insight of the risks and rewards in the market. This type of analysis is helpful for both new allocations into the market and for assessing the potential for restructuring a portfolio. Horizon analysis is not a predictor of future interest rates. Interest rate forecasts come from economists, but once views on future interest rates are determined, horizon analysis can assist in selecting both where on the yield curve to invest as well as which bond structure is most appropriate.
- Sector relative value analysis measures available yields, yield spreads, and yield ratios against historical relationships to benchmark treasuries to determine which asset classes are more or less attractive.
- Asset/liability matching frameworks are utilized in creating portfolios that are designed to be as efficient as possible when reinvesting proceeds from bond sales for construction projects or escrowing of future liabilities.
Interest rates, economic conditions, issuer credit quality, tax rates, currency values – and, therefore, the relative value of fixed income asset classes – all are subject to change. The supply of new bond issues waxes and wanes and market-changing events occur, as do personal life events and changes in residence; these are all front-page and commonplace events that can prompt an advantageous adjustment to a portfolio.
Taking a buy-and-hold approach has the potential to negatively impact a portfolio due to lack of attention. On the other hand, actively trading a fixed income portfolio, particularly for a taxable investor, also may have potentially negative consequences related to excessive transactions costs, tax inefficiency, and “whip-sawing” during fast-moving markets. There is a point in the middle, an equilibrium “buy-and-manage” approach, where portfolios are adjusted due to aging, a modification of market view, or change in personal circumstance.
The debate regarding buy-and-hold investment strategies versus active management will never end, because neither method has the right answers for all investors and asset classes. The optimal approach for many investors may very well be a combination of managed and transactional based upon the strategies, vehicles, and asset class mix.
Investor-specific circumstances may give one method greater appeal than the other. The choice should depend upon: 1) investment objectives, 2) asset class, 3) the rate of asset turnover, 4) the average maturity of the portfolio, 5) commission rates, 6) the amount of management fee charged, 7) legal liability considerations, and 8) the desire/ability of the investor to be meaningfully involved in the management process of the portfolio.
We believe that for most investors, considerations 7 and 8 are most important.
When considering item 7, do you as a guardian, trustee, or public official want to take personal responsibility for each and every transaction or outsource that responsibility to a portfolio manager? Item 8 expands upon item 7, asking if the person responsible for investments has the desire/ability to be meaningfully involved in the management process.
Finally, we believe investors are best served by finding a highly skilled and knowledgeable fixed income professional with a high information ratio and extensive portfolio management experience. We believe Stifel Capital Management meets and exceeds those requirements, and we stand ready to assist you with your fixed income portfolio needs.