InvestorQ : What do we understand by passive bond portfolio strategies?
prachi Patwardhan made post

What do we understand by passive bond portfolio strategies?

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1 year ago
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Whether it is investing in equities or in bonds, there is always an active approach and there is also a passive approach. In active approach, you get involved in regular decision making on bond purchases and sales. But in case of passive bond portfolio management, there is limited active involvement and the focus is more on doing rule based investing in bonds.

There are different types of strategies that can be deployed to manage the returns and risk of a bond portfolio; some of the more widely-used strategies are known as:

Indexing

Immunization

With an indexing strategy, the portfolio manager attempts to replicate a bond index, such as the CRISIL Bond Index. The focus, like in case of an equity index fund, is more on managing the tracking error than trying to beat the index. Due to the varied features of bonds, this is a more difficult objective to accomplish than replicating a stock market index. With an immunization strategy, the risk of a portfolio is managed by attempting to ensure that the duration of a bond portfolio matches a specified investment time horizon. The goal is to ensure that the portfolio will provide a certain rate of return by the end of the time horizon.

How are bond portfolios immunized. Let us look at this with a simple example. If you have a payable of Rs.10 lakhs after 5 years then should you match with a bond of the same maturity? The problem is that it exposes you to interest rate risk. The alternative is to match up the tenure of the liability to the duration of the bond rather than the maturity of the bond. For example, if you have a payable after 5 years, then you must buy a bond with duration of 5 years and not a bond with term to maturity of 5 years if you really want to protect yourself from interest rate risk.

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