Overview of Fixed-Income Portfolio Management

Investors often seek regular income from their investments as well as a predetermined date when their capital will be returned. Fixed-income investments offer both.

Fixed-income instruments include a broad range of publicly traded securities (such as commercial paper, notes, and bonds traded through exchanges as well as OTC) and non-publicly traded instruments (such as loans and private placements). Individual loans or fixed-income obligations may be bundled into a pool of assets supporting such instruments as asset-backed securities and covered bonds. Fixed-income portfolio managers combine these diverse instruments across issuers, maturities, and jurisdictions to meet the various needs of investors. We discuss the different roles of fixed-income securities in portfolios and explain the two main types of fixed-income mandates—liability-based mandates and total return mandates—as well as bond market liquidity. We also provide an overview of portfolio measures, instruments, and vehicles used in fixed-income portfolio management and introduce a model of how a bond position’s total expected return can be decomposed.

We explain liability-driven investing in fixed-income investing by demonstrating how to best structure a fixed-income portfolio when considering both the asset and liability sides of the investor’s balance sheet. We introduce the idea of structuring a bond portfolio to match the future cash liabilities that have bond-like characteristics. Asset–liability management (ALM) strategies are based on the concept that investors incorporate both rate-sensitive assets and liabilities into the portfolio decision-making process. When the liabilities are given and assets are managed, liability-driven investing (LDI), a common type of ALM strategy, may be used to ensure adequate funding for an insurance portfolio, a pension plan, or an individual’s budget after retirement. T he techniques and risks associated with LDI are introduced and then expanded to cover both cash flow and duration-matching techniques and multiple liabilities. This strategy, known as immunization, may be viewed simply as a special case of interest rate hedging.