We believe that a strategic, actively managed approach to fixed income investing often outperforms the alternative. You might be familiar with active management when it comes to equities, but what does that actually look like in the fixed income market? And is it really better?
Let’s dig into it.
What Does Active Management of Fixed Income Securities Entail?
Active management of fixed income securities involves a hands-on approach where portfolio managers continuously analyze, adjust, and optimize an investment portfolio based on market conditions, economic data, and individual security performance (all on a tax-efficient basis). Active management involves a lot of different considerations, so here’s a few key ones to give you an idea of what it looks like:
- Economic Indicators: Portfolio managers examine key economic indicators such as GDP growth, employment rates, inflation measures (CPI, PPI), and housing market data to assess the overall health of the economy. For example, if inflation is rising, managers might adjust the portfolio to include more inflation-protected securities.
- Monetary Policy: Monitoring central bank actions, such as interest rate changes and quantitative easing measures, is crucial. These policies influence bond yields and prices, and managers will adjust the portfolio to mitigate risks or capitalize on opportunities.
- Credit Analysis: Assessing issuers' creditworthiness is vital. Managers review corporate financial statements, sector performance, and credit ratings to select bonds with favorable risk-reward profiles.
- Sector Allocation: Managers diversify across various sectors (e.g., government, corporate, municipal bonds) to spread risk and capture different yield opportunities.
- Comparative Analysis: Managers compare bonds within the same sector or credit quality to find undervalued securities. They might look for bonds with higher yields relative to their peers or those offering better credit spreads.
- Tax Considerations: For taxable accounts, managers evaluate the after-tax yield of bonds, selecting those that provide the best returns after considering tax implications.
- Liquidity Management: Ensuring sufficient liquidity is key. Managers maintain a balance between higher-yielding, less liquid bonds and more liquid securities to meet potential redemption needs.
- Performance Evaluation: Managers regularly review portfolio performance against benchmarks and adjust strategies as needed. This involves rebalancing the portfolio to align with changing market conditions or investment goals.
Example of Active Management in Practice
Imagine a scenario where economic data suggests an upcoming interest rate hike by the central bank. In response:
- Top-Down Adjustment: The manager might reduce the portfolio's duration
- Bottom-Up Selection: Within the corporate bond sector, the manager identifies high-quality companies with strong balance sheets that are likely to withstand economic tightening
By actively managing the portfolio in this manner, the manager aims to enhance returns, manage risks, and align the investment strategy with the current and anticipated market environment.
The Case for Active Management
So, why choose active management over a passive approach? Here are some of our most compelling reasons:
Adaptability: Markets are dynamic, and active management allows us to respond to changes swiftly, seizing opportunities that passive strategies might miss.
Risk Management: Active management enables us to mitigate risks more effectively, whether through diversification, strategic positioning, or adjusting exposure based on real-time data.
Total Return Focus: By focusing on total return and only taking compensated risks, we aim to provide superior long-term income streams for our clients.
Empirical Evidence: Our empirical research supports the effectiveness of a laddered portfolio strategy, maximizing after-tax risk-adjusted returns.
CDI's Commitment to Excellence
Building fixed income portfolios requires commitment to an investment philosophy, a structure that works for investors over the long term, and finally, discipline (usually gained through experience). We at City Different Investments possess all three. We are committed to our total return philosophy which dictates that we only take risk when we are getting paid to take risk (much of our time is spent evaluating the risks and their comparative value in the fixed income markets). We know who we are and don’t deviate from our total return approach and actively laddered structure. We don’t make big duration / credit bets but rather focus on return per unit of risk.
We believe in the power of active management and the value it brings to our clients. Our data-driven, research-intensive approach aims to result in consistent returns while managing risks effectively. By combining top-down and bottom-up research, leveraging technology, and maintaining a disciplined risk management framework, we provide a robust strategy that stands out in the fixed income landscape. We never completely abandon a risk factor but instead continuously assess and adjust based on real-time data.
If you're interested in learning more about how CDI's active management strategies can benefit your fixed-income investments, feel free to reach out to our Portfolio Managers — they’re always happy (truly) to speak directly to clients or partners!
IMPORTANT DISCLOSURES
The information and statistics contained in this communication have been obtained from sources we believe to be reliable but cannot be guaranteed. Opinions and statements of financial market trends that are based on market conditions constitute our judgment and are subject to change without notice. Any projections, market outlooks or forecasts discussed herein are forward-looking statements and are based upon certain assumptions. Other events that were not taken into account may occur and may significantly affect the returns or performance of these investments. Any projections, outlooks or assumptions should not be construed to be indicative of the actual events which will occur. Please remember that past performance may not be indicative of future results.
Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product, or any non-investment related content, made reference to directly or indirectly in this communication will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. No discussion or information contained herein serves as the provision of, or as a substitute for, personalized investment advice. To the extent that a reader has any questions regarding the applicability above to his/her individual situation of any specific issue discussed, he/she is encouraged to consult with the professional advisor of his/her choosing. City Different Investments is neither a law firm nor a certified public accounting firm and no portion of this content should be construed as legal, tax, or accounting advice.