• There are only 2 things to do with money:
Fixed Income Investment Management
on Process and Discipline Behind the Process
Few Facts About Bonds And Fixed Income
-- Spend it
-- Invest it
There are traditionally three
core areas for investments:
- Stocks are all about capital gains.
- Real estate is all about location … and rent.
- Bonds are all about the income.
- And the Bond Market is one big organized
and regulated I.O.U.
- Some people always need to borrow money.
- Some people like to borrow money so
they can buy things today, even though they don’t have the cash today.
- Some people seem to always have money
that could be invested … if the terms were right.
- Borrowers and lenders … those who “want”
or “need” versus those who “have.”
- When a borrower and a lender come together, they develop
a mutual understanding . They create a “bond” between themselves … each one can benefit with the help of
- What does the borrower have to offer ? ( interest income )
- How good is the borrower’s promise
to repay the loan ?
- What does the lender want ? ( return of principal and interest income )
- What is this I.O.U worth ?
– a 1-day promise ?
– a 30-year promise ?
- There are two types of quality:
– Junk … High Yield …
- There are two types of bonds:
– Fully taxable at the Federal and State level
– Tax advantaged
at Federal and/or State level
- There are four ways to invest in bonds:
– Exchange Traded
Products ( ETPs )
- There are six main sectors:
– U.S. Government Sponsored Enterprises ( Agencies )
– Structured Products ( Mortgages and Asset-Backed )
– Cash and Cash Equivalents
- Rates change either because the credit quality changes or because the “economy” changes.
- The coupon payment does not get interrupted
just because the price changes
- If interest rates go up because the economy is doing better and the economy is generating some inflation,
a bond investor has to be able to live with the fact that the price of a bond or a bond portfolio may go down. But the coupon
payment does not get interrupted.
- If interest rates go up because the perceived credit quality of the borrower has deteriorated, then
the bond investor may have a problem with his loan to this borrower. But perceived deterioration of credit quality does not
cause the coupon payment to be interrupted.
- Prices change daily. Coupon payments do not.
- And the typical bond investor only
cares about the coupon payments ( the interest income ), not the daily price change of a bond based on variables outside of
– Sorted by
- There are three classifications of quality:
- There are three primary measures of
Tax-free yield as a percent of Treasuries
– Tax-free yield spread to the MMD scale
– Taxable equivalent
yield spread to Treasury curve
- There are 4 ways to buy municipal bonds:
– Exchange Traded
Products ( ETPS )
- The spread may be the most important characteristic of a corporate bond. It theoretically quantifies
the credit risk compared to a bond with an assumed zero credit risk ( a U.S. Treasury )
- Corporates are priced at a “spread”
relative to Treasuries.
- When Treasury yields go up, spreads narrow (go down); when Treasury yields go down, spreads widen
(go up). If Treasury yields are going up then the assumption is the economy is strong and inflation is moving higher. Then
the ability of a corporation to make its debt payments are high because business is good, the company is making money so it
has the cash to pay its bills ( interest income is a bill that a company has to pay ). If Treasury yields are going down,
then the assumption is the economy is doing bad and inflation is not a problem. If the economy is doing bad, then the company
is not making money and the company may have a hard time paying their bills. The risk is higher that the company won’t
be able to make its debt payments so spreads move wider/higher to compensate for the higher risk.
- Coupon + price = total return
- Buy a 5.00% coupon at par ($100.00)
- Rates are unchanged after 1-year
– Total return = 5.00% ( coupon return of 5% with zero
price return )
- Rates go up 100 basis points in 1 year
- Total return = 5.00% coupon return + price drop of
bond ( since interest rates went up prices went down ) resulting in total return less than 5.00%
- Rates go down 100 basis points in 1
– Total return
= 5.00% coupon return + price increase of bond ( since interest rates went down prices went up ) resulting in total return greater than 5.00%
- Coupon return versus price return.
- An account has to make a decision on
the preference for income or total return.
- What is the importance of an index or a benchmark to the investor ?
- How do you select an index or a benchmark
- Are you willing to see total return numbers below an index ?
- Are you willing to see negative total
return numbers ?
- Does the investor have a budget for realized losses for the bond portfolio
- U.S. Government – 35% of the
- U.S. Government Agencies – 11% of the taxable market
- Corporations – 20% of the taxable
- Mortgage borrowers – 34% of the taxable market
- Cities, counties, school districts,
States, et. al – 100% of the tax-free market
- If the investment mandate allows for
the sale of a security before its maturity date, a holding may become a candidate for sale as a result of any of the following:
– The issuer’s credit fundamentals begin to deteriorate
– When the individual security no longer meets the portfolio’s
– When the account
must meet an unknown liquidity need
– When the Yield
Curve Model or the Duration Model or the Credit Model signals a change in trend and subsequent market conditions
What Should An Investor Look For In
An Investment Manager?
- Expertise in the part of the yield curve specific to the liquidity and risk profile of the funds
available for management.
- Assets under management specific to maturity profile and tax profile and sector profile of funds
available for management.
- A manger who has been trained to manage money…be very careful of “managers” who
are trained to sell bonds.
- Traditional Yield Curve Decision
- Traditional Duration Decision
- Careful Security Selection
– Credit Quality Perspective
– Relative Value
– Realizing Paper Profits
– Reallocation Based on Model Recommendations
- A bond investor must accept the fact
that month-end custodian prices may, and probably will, be different than the original purchase price.
- A bond investor should adopt a philosophy
of a buy and hold strategy. Selling a bond before its maturity can be justified in certain circumstances.
- A bond investor must be able to tolerate
a change in the credit rating assigned to an individual security, by one or more of the nationally recognized credit rating
- A bond investor must have a willingness to tolerate month-end custodian price swings based on market
events and based on individual security events, as long as the risk to income and the risk to principal repayment are