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November 27, 2014

Fixed Income Perspectives: How Much Risk

How We Feel About Risk

At Reinhart Partners, we remain convinced that the portfolio’s protracted stance of protecing capital from potential market shocks continues to be more appropriate in today’s environment than increasing risk to achieve a slight increase in portfolio yield. While this is easy to say, let’s look at the numbers:

Today’s Portfolio Structure versus “Fully Risked” Portfolio

Adherence to our conservative style of fixed income investing is the hallmark of Reinhart Partners. Managing within this philosophy allows us to add risk when we are being appropriately compensated while remaining true to our conservative nature. In order to test risk/reward tradeoffs available in today’s markets, it is helpful to compare our current portfolio with a more aggressive portfolio structure that could be utilized within our style. We build this “fully risked” portolio in two steps. First, we add to credit, taking the sector weight from the current 51.5% to 60.25%. Second, we move our Treasury position to the short end of the curve while concurrently repositioning corporates longer. When completed, the duration of the corporate sector moved from 3.17 to 4.88 while the treasury sector dura on fell from 6.94 to 2.37. Overall portfolio duration remains the same.

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The Results

By comparing the two portfolios, we can now quantify the “slight increase in portfolio yield.” Adding as much risk as possible within our style increases the portfolio yield by just 10.5 basis points. The amount of risk added to achieve this yield increase becomes apparent when looking at total returns achieved in spread widening environments. As can be seen in the chart on the right, the current portf olio holds its value much be er in the event of wider spreads. The slight increase in portfolio yield does not compensate for the added risk.

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