Fixed Income Strategy
To the extent that investors are putting risk capital to work in stocks, accepting higher volatility in exchange for higher returns, the bond side of the portfolio has traditionally acted as a counter-balance, helping to mitigate overall portfolio volatility while also producing a steady stream of income. In recent years, the income part has not been as prominent, but the risk and volatility management – the ballast function – retains its importance.
"Bond selection is primarily a negative art. It is a process of exclusion and rejection, rather than of search and acceptance."
Even if bonds represent a “less risky” allocation vs. stocks, they still have some investment risks. These include:
Default Risk – the possibility that you will not get your money back at maturity.
Volatility Risk – changes in interest rates can lead to interim bond price changes, which can, in turn lead to …
Liquidity Risk – the possibility that a sale of a bond before maturity might only be accomplished at a loss, thus limiting flexibility.
We manage these risks with a nod to Benjamin Graham, by excluding unfavorable characteristics, as follows:
- We stay well within investment grade rating limits and generally insist on at least an “A+” underlying rating. We do not “reach” for yield by buying lower quality.
- Unlike many advisors, we build bond portfolios using individual bonds, rather than using funds or ETF’s, making it very easy for us, and you, to know what you own and when you will get your money back. That will generally be U.S. Government securities or well-rated tax-free Municipal bonds.
- With regard to volatility, staying with Investment Grade issues helps by itself, but we also keep average maturities fairly short, currently in the 3-5 year range. In the present environment, going longer increases risk, but does not materially improve the reward, income.
- We also employ a “laddered” maturity schedule to arrive at the 3-5 year average maturity, with issues coming due, and paying off, every year or so. This gives our clients the opportunity to consider the following questions: Should I reinvest in another bond? Should I reallocate to stocks? Do I need the money for another purpose?
- Finally, and particularly with Municipals, we build a diversified portfolio of different issuers, types, geographies, to “spread the bets around”.