Why We Ladder Short- and Intermediate-Term Bonds February 2009 (updated March 2014) Christopher Ryon, cfa | Portfolio Manager Laddering Strategy: BofA Merrill Lynch 1–12 Year Municipal Index Yr 10+ Yr 9 Yr 8 Yr 7 Yr 6 Yr 5 Yr 3 Yr 4 One of the tools we use at Thornburg to manage our core fixed income portfolios is laddering bond issues. Contrary to some perceptions, laddering is not a passive investment strategy; rather it’s one of several active techniques managers have at their disposal to manage duration risk. The discipline of laddering frees us to determine which sectors of the market offer the best relative value and which issues within those sectors provide the highest potential return for a given level of risk. Laddering as Means to Balance Different Risks Yr 2 Yr 1 14% 11% 10% 10% 9% 9% 8% 8% 8% 13% Percent of portfolio maturing in each year (as of 12/31/13) Laddering involves building a portfolio of bonds with staggered maturities so that a portion matures each year. Money that comes in from maturing bonds is typically invested in bonds with longer maturities at the far end of the portfolio. Laddering is effective in that it accomplishes several goals: ■■ Barbell Strategy: ■■ BofA Merrill Lynch 1–3 Year and 8–12 Year Municipal Indices ■■ 1–3 yr Index 48% 8–12 yr Index 52% Bullet Strategy: 1–3 yr BofA Merrill Lynch 6–8 Year Index Municipal Index 48% 6–8 yr Index It captures price appreciation as bonds age and their remaining life shortens Principal is reinvested from maturing shorter-term bonds (which, when the yield curve is normal, have lower yields) into longer-term bonds, with higher yields It has the potential to maximize income and, because portfolio turnover is low and we manage capital gains exposure, tends to be tax efficient A Look at Laddering’s Effectiveness Versus Other Strategies We examined three hypothetical portfolios of bonds over the last 17 years: one using a laddering strategy, one using a barbell strategy, and a third using a bullet strategy. The barbell strategy is a duration management technique wherein bonds are clustered at the two extremes of a maturity range. For the laddering strategy, the BofA Merrill Lynch 1–12 Year Municipal Index was used as a proxy, since, similar to a ladder, it contains bonds relatively evenly spread across all maturities within the index. For the barbell strategy, the BofA Merrill Lynch 1–3 Year Hypothetical Ladder Structure Outperformed, as of 12/31/2013 Difference in Total Returns Ladder vs. Bullet Annualized 12/31/13 12/31/12 12/31/11 12/31/10 12/31/09 12/31/08 12/31/07 Barbell / Bullet 12/31/06 Outperformed 12/31/05 12/31/04 12/31/03 12/31/02 12/31/01 12/31/00 12/31/99 12/31/98 12/31/97 -1.50% -1.00% Year Annualized 2013 2012 2011 2010 2009 2008 2007 2006 2005 2004 2003 2002 2001 2000 1999 1998 1997 Ladder vs. Barbell Ladder Outperformed -0.50% 0.00% 0.50% 1.00% 1.50% Source: Bloomberg and Thornburg Investment Management. Past performance does not guarantee future results. Total Returns Ladder Barbell Bullet 4.89% 4.58% 4.66% -0.12% -0.49% -0.75% 3.40% 3.48% 3.44% 7.59% 7.87% 8.31% 3.04% 2.54% 3.70% 7.19% 6.47% 6.10% 4.61% 4.11% 4.05% 4.98% 4.70% 4.10% 3.77% 3.95% 3.21% 1.87% 2.07% 1.51% 3.44% 2.95% Series2 3.40% 4.82% 4.51% 5.33% 10.48% 9.67% 11.55% 5.15% 4.70% 5.21% 9.64% 9.50% 9.53% -0.01% -0.06% -0.86% 6.27% 6.52% 6.08% 7.69% 7.78% 7.50% Diff. v. Barbell 0.31% 0.38% -0.08% -0.28% 0.50% 0.71% 0.50% 0.28% -0.18% -0.20% 0.50% 0.30% 0.81% 0.44% 0.14% 0.05% -0.25% -0.09% Diff. v. Bullet 0.22% 0.64% -0.04% -0.73% -0.67% 1.09% 0.57% 0.88% 0.56% 0.36% 0.04% -0.52% -1.07% -0.06% 0.11% 0.85% 0.19% 0.19% Ladder outperforms Municipal Index and BofA Merrill Lynch 8–12 Year Municipal Index were combined. The two indices were weighted in such a way as to give them the same duration as the broader 1–12 Year Index, and each year the portfolio was re-weighted back to the original index weights. This was done to make the two portfolios duration-neutral so that the impact of the strategy chosen could be isolated. The BofA Merrill Lynch 6–8 Year Index was used to represent the bullet strategy. A glance at the chart on page one shows that the laddering strategy outperformed the barbell in 11 years, and the bullet in 11. More telling, however, was the level of outperformance in different environments when the yield curve was undergoing periods of flattening or steepening. In the years when the laddering strategy outperformed, it did so, on average, by a larger margin than when the barbell or bullet strategies came out ahead. For example, in 2006, as investors were taking a complacent attitude towards risk, the yield curve flattened (see chart below), especially as leveraged investors entered the market. During that period, the barbell strategy outperformed by roughly 18 basis points. In the period of greatly heightened risk aversion in 2008, the curve steepened significantly, and the laddered strategy outperformed the barbell by 50 basis points and the bullet by 57. A longer-term track record is built from many smaller ones, though, and after 17 years, the ladder had outperformed the equivalent barbell strategy by 31 basis points annually and the bullet by 22 basis points annually. In a period during which bond insurance* is less and less prevalent and its value questioned – and with some municipalities under financial stress and sometimes limited market liquidity – fundamental research on individual issues is more important than ever. Laddering has been demonstrated to be an effective technique for managing market and reinvestment risk, freeing Thornburg’s managers to focus on those areas of critical importance in today’s environment. The laddering strategy does not assure or guarantee better performance than a non-laddered strategy and cannot eliminate the risk of investment losses. AAA Municipal Yield Curves 6 12/28/06 5 12/31/08 Yield (%) 4 3 2 1 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 Years to Maturity Source: Thornburg Investment Mangement Basis Point – A unit equal to 1/100th of 1%. 1% = 100 basis points (bps) Duration – A bond’s sensitivity to interest rates. The BofA Merrill Lynch indices used in the study are model portfolios of municipal obligations throughout the United States, with maturities ranging either from one to three years, six to eight years, eight to twelve years, or one to twelve years. These indices are subsets of the BofA Merrill Lynch US Municipal Securities Index, which is comprised of US dollar denominated investment grade tax-exempt debt publicly issued by US states and territories, and their political subdivisions, in the US domestic market. Qualifying securities must have at least a oneyear remaining term to final maturity, a fixed coupon schedule and an investment grade rating. The performance of any index is not indicative of the performance of any particular investment. Unless otherwise noted, index returns reflect the reinvestment of income dividends and capital gains, if any, but do not reflect fees, brokerage commissions or other expenses of investing. Investors may not make direct investments into any index. * Individual bonds are sometimes insured by private companies. The insurance guarantees the payment of principal and interest on a bond issue if the issuer defaults. In 2007 and 2008, the credit ratings of many bond insurers were downgraded, reflecting a decrease in claims paying ability of the insurers. Bond mutual funds are not insured, even if the underlying bonds are insured. Investments in the Funds carry risks including possible loss of principal. As with direct bond ownership, funds that invest in bonds are subject to certain risks including interest-rate risk, credit risk, and inflation risk. The principal value of a bond will fluctuate relative to changes in interest rates; as interest rates rise, the overall price of bonds fall. Unlike bonds, bond funds have ongoing fees and expenses. Investments in the funds are not deposits or obligations of, or guaranteed or endorsed by, any bank, the Federal Deposit Insurance Corporation, the Federal Reserve Board or any governmental agency. Thornburg municipal funds may be subject to the Alternative Minimum Tax. Before investing, carefully consider the Fund’s investment goals, risks, charges, and expenses. For a prospectus or summary prospectus containing this and other information, contact your financial advisor or visit thornburg.com. Read them carefully before investing. Thornburg Securities Corporation, Distributor 2300 North Ridgetop Road Santa Fe, New Mexico 87506 877.215.1330 4/17/14 TH1858
© Copyright 2024