There are many different approaches that can be used by a portfolio manager who is attempting to beat the performance of a bond index. Some of these approaches overlap with Equity investing but some are very specific to the fixed income Market.
These approaches can be split down into two broad categories. First of all, when we expect yield curve stability, which is another way of saying that we expect interest rates to be relatively constant over our investment Horizon. And the second group of approaches we could use is where we expect there to be changes in the yield curve changes in interest rates. If we expect yield curves stability. Then we could engage in Buy and Hold strategies. Which involves constructing a portfolio of the Securities from the index but where we're holding different weights from those Securities in the index may be driven by different exposures to factors such as credit risk or exposures to different industrial sectors the alternative approach. Is to engage in rolling down the yield curve. This strategy is very much specific to the fixed income market and involves buying longer dated bonds than the Target Time Horizon of the investor.
And then rather than waiting to reach the maturity date on those Securities and receiving the Redemption cash flows. We would sell the longer dated security at our required liquidity point.
By buying longer data Securities and then selling them when the cash is required greater levels of returner generated in comparison to buying a security which has the same maturity as our Target investment Horizon.
This does no rely on the yield curve remaining stable.
If however we have an expectation that there's going to be changes in the yield curve or interest rates. We could be able to position our portfolio to benefit from those expected changes in interest rates. Firstly through duration management, which involves adjusting the duration of our portfolio to take advantage of those expected changes and interest rates by increasing the duration. If we think that interest rates are about to fall and then bond prices increase we want more exposure to that change in price through holding higher duration bonds within the portfolio and conversely if we were anticipating and increase in interest rates and therefore a fallen bond prices. Well, if we're a bond portfolio manager, we've got to invest in bonds. So we might like to reduce our exposure to that change in interest rates by holding shorter dated bonds. So even though our portfolio might fall in value we suffer less of a fall in value than the Benchmark does Alternatively, we might look to benefit from changes in the shape of the yield curve. bullets and barbell portfolios relate to investing at different points along the yield curve a bullet portfolio has bonds within the portfolio or which have a duration very similar to our Target duration a barbell portfolio would have a group of bonds with a lower duration than the Target and another group of bonds with a higher duration than the target which average out to give us our overall Target duration. These bullet and barbell portfolios perform differently when there is a change in the slope of the yield curve or a Twist in the yield curve if we can forecast those changes in the shape of the elkovel twists in the yield curve. We can position the portfolio to take advantage of those anticipated changes happening.
