I have a question about real world asset management that relates to the curriculum.
Take an individual investor, lets assume their risk tolerance dictates low risk. i.e. 64 years old and 750,000 in retirement funds (ignore return requirements, but assume the 750k is not a lot of money...they don't live in Kenya..., its not relevant to this question).
Lets assume again a high allocation to bonds is prudent.
How does one reconcile the fact that in an environment like this one (low low interest rates) that as the economy gets better, yields are bound to increase, thus dropping the value of the bonds....
I realize more bond exposure lowers income risk, but what about the horrible price risk in the portfolio.
How would a private wealth manager deal with putting a customer in piles of bonds when rates have only one direction to go, long term?作者: yospaghetti 时间: 2011-7-26 20:43
Buy short duration stuff!作者: bleach 时间: 2011-7-26 20:49
soddy1979 Wrote:
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> Buy short duration stuff!
Is that the answer? Short Duration and trade a bunch? What if you want to park their money? Is it even prudent to just park it?作者: dvilayphet 时间: 2011-7-26 20:54
If the client cant stomach capital losses, then I think short duration investments are prudent. You reconcile this to the size of the portfolio, by a reduction in their ability to spend.
Needing more money (or a higher return) is not a valid reason for taking on increased risk.作者: Unforseen 时间: 2011-7-26 20:59
soddy1979 Wrote:
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> If the client cant stomach capital losses, then I
> think short duration investments are prudent. You
> reconcile this to the size of the portfolio, by a
> reduction in their ability to spend.
So the answer is duration based, but even shorter duration is exposed, correct?
> Needing more money (or a higher return) is not a
> valid reason for taking on increased risk.
I'm assuming your making this statement based on the idea that other non bond investments will be riskier so bonds are the least of the "risk evils" despite the price risk?作者: smuggycfa 时间: 2011-7-26 21:05
> So the answer is duration based, but even shorter
> duration is exposed, correct?
Yes, if you want the higher returns associated with bonds (relative to cash), you will need to take on a certain level of price risk.
>
> > Needing more money (or a higher return) is not
> a
> > valid reason for taking on increased risk.
>
> I'm assuming your making this statement based on
> the idea that other non bond investments will be
> riskier so bonds are the least of the "risk evils"
> despite the price risk?
Yes, generally a lower risk tolerance, indicates a higher allocation to fixed income, because they are less risky than equity investments. You could protect your bonds if you expected an increase in rates though, using options or something else, but of course you will be forgoing income in this case.
Why don't you buy your client some floaters? You won't have a problem with price risk with these, but you will have cash flow risk.作者: thecfawannabe 时间: 2011-7-26 21:10
soddy1979 Wrote:
-------------------------------------------------------
> > So the answer is duration based, but even
> shorter
> > duration is exposed, correct?
>
> Yes, if you want the higher returns associated
> with bonds (relative to cash), you will need to
> take on a certain level of price risk.
>
> >
> > > Needing more money (or a higher return) is
> not
> > a
> > > valid reason for taking on increased risk.
> >
> > I'm assuming your making this statement based
> on
> > the idea that other non bond investments will
> be
> > riskier so bonds are the least of the "risk
> evils"
> > despite the price risk?
>
> Yes, generally a lower risk tolerance, indicates a
> higher allocation to fixed income, because they
> are less risky than equity investments. You could
> protect your bonds if you expected an increase in
> rates though, using options or something else, but
> of course you will be forgoing income in this
> case.
>
> Why don't you buy your client some floaters? You
> won't have a problem with price risk with these,
> but you will have cash flow risk.
Well, I don't have a client per se,
I am just trying to answer the question of when interest rates are incredibly low, why would anyone ever want bonds since the value has nowhere to go but decline...I figured there had to be some strategy...作者: mp3bu 时间: 2011-7-26 21:16
You can by more bonds that may be priced inefficiently like MBS and munis. If your "client" had a bit more money they can get munis in a separate account structure. Buying munis in a separate account decreases the pain of shifting whims of the retail mutual fund base and an adept manager can find a lot of value in munis due to their inefficient trading. Those are just two ways to get a little bit yield in the bond portfolio for people with a need for a high allocation to fixed income.作者: wizofoz 时间: 2011-7-26 21:21
having high exposure to bonds at a late age is not actually an ultimate rule! this is just a general guidance. When you determine your strategic asset allocation it holds, but there is also tactical asset allocation, when you try to employ cyclical or other short-term market opportunities. So you may deviate from the strategic asset allocation. You must always take into account capital markets expectations作者: Chuckrox 时间: 2011-7-26 21:27
A too long of a low interest rates would give rise to inflation. The curriculum recommends holding cash on a rising interest rate. This is consistent with having a short duration fixed income.作者: iteracom 时间: 2011-7-26 21:32
Maybe this response is too simplistic but wouldn't you only be concerned with a capital loss if you were trying to trade or liquidate the bonds? Remember, there are a number of reasons to trade bonds which include mis-pricing / gain opportunities. Plenty of institutions / individuals do not trade bonds and hold them to maturity. At the end of the life, regardless of interest rates, you will still get principal (assuming no default) with coupon payments along the way.作者: pawn 时间: 2011-7-26 21:43
If you're talking about the current real world environment, I hate to tell you, but interest rates in the U.S. are not going to rise for years, probably 5 years. In this sort of environment, where interest rate hikes continually get pushed out, longer-term bonds will do better than shorter-term bonds. The Federal Reserve, after expanding its balance sheet so much, has many tools to tighten, before it will revert to raising interest rates.作者: Windjam 时间: 2011-7-26 21:49
I dont know bout you, but I am a fan of floating rate bonds and think a portoflio could benefit from having a small portion allocated to them (duration is pretty much 0, gain from increase in rates).
But these can also be riskier, as we saw in the collapse of 2008.
