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