Yield is important. So is stability. That’s why our philosophy is to selectively take on moderate risk exposures when the reward for doing so is favorable.
We believe that successful fixed income management is a product of maintaining a conservative discipline that does not take undue risks in pursuit of yield, but rather selectively takes on moderate risk exposures when the risk/reward tradeoff for that exposure is favorable.
Interest Rate Risk
Interest rate risk is the most prevalent risk in any fixed income portfolio. The fact that interest rates move in cycles presents an opportunity to enhance the income generating ability of a portfolio. In general, we concentrate portfolios in shorter maturities during rising interest rate environments and longer maturities when rates are falling.
In order to effectively reduce the risk of an overall portfolio, the fixed income allocation must have a low correlation to other asset classes included in an investor’s overall asset allocation. This is most effectively achieved by concentrating on very high quality securities.
We utilize callable bonds to the extent that the additional yield gained from the callable security offsets the loss of cash flow certainty. Typically, this occurs most often when giving up only slight call protection. We are able to enhance the income of our portfolios by owning this type of bond without unduly increasing reinvestment risk. We use far fewer callable bonds than exist in our benchmark.
Many factors must be considered when building an optimal portfolio. Our fixed income team uses the macroeconomic landscape, relative value between sectors, and issue level risk/reward analysis as inputs to make portfolio decisions such as portfolio duration, sector contribution to duration, yield curve positioning and structure exposure.
Every portfolio we build is unique, as dictated by the diverse needs of our clients. Each individual client’s income requirements, liquidity needs, investment horizon and related risk tolerance drive our tax sensitive fixed income process.
No two clients will have the same tax situation. A client’s marginal tax bracket, state of residence, AMT concerns and capital gains positions are all considered while formulating the optimal portfolio.
Municipal Credit Risk Assessment
We rank all 50 states using an internal ranking system. We look at many different statistics including but not limited to: long term debt to GDP ratio, interest expense to revenue ratio and pension liabilities.
The United States has 3140 counties. We internally rank the 1816 counties which have populations over 25,000. Some of the statistics that we consider include: median household income, unemployment, and the percentage of the population below the poverty level.
We choose bonds of individual municipalities based on the strength of the county and the state. We compare bonds of similar structure, quality and maturity to find the best issue at the time of purchase.
Issue Level Selection
A well balanced portfolio will contain municipal issues backed by both the revenue of specific projects and by the general obligations of individual communities. We focus our investments in geographically stable regions of the country while diversifying individual state exposure as much as possible. Often, state exposure will be driven by tax regulations in the clients state of residence. Geographical diversity increases the safety of the municipal portfolio as each bond is exposed to different economic circumstances.
Tax Exempt Portfolio Manager