Portfolio Characteristics (Week 0)

This post will look in more detail at the characteristics of the portfolio of corporate bonds constructed and also see how the portfolio performs in a one-year backdate test.

The table below shows the full details of each of the bonds hand picked for the portfolio. Individual bonds were not selected based on their coupon rates or yield-to-maturity. Instead, bonds were selected according to the diversification criteria discussed in the previous blog post.

Looking at the summary of holdings below gives a quick indication that bonds are fairly evenly spread across denominations in 6 different currencies. Furthermore, each individual bond has been assigned the same weighting; each of the 40 stocks chosen were allocated weightings of 2.5%. This follows the simple 1/N allocation strategy.

The view below in Bloomberg has been customized to analyse the portfolio by currency segments. It can be seen that the Australian segment of bonds has significantly lower average maturity (Mty=5.23 yrs) and thus also lower modified duration (ModDur=4.45). Modified duration gives a first order approximation for how the bond's price will react to a 100 basis point change in interest rates. If interest rates in Australia were to rise by 1%, this figure predicts a 4.45% drop in the price of the bonds. 

The Australian bonds had lower maturities since there were no AUD denominated bonds at longer maturities. Most Australian bonds at longer maturities were denominated in USD. So this is largely an artifact of the selection rules applied to the portfolio. It will be interesting to note whether the AUD segment performs comparatively better if a general decline in interest rates is observed.

A replicate of the portfolio has also been constructed one year prior so that the backdated performance of the portfolio can be analysed between 17/02/14 and 17/02/15. Backdating is certainly not the most reliable measure of future performance, but it is a useful procedure for getting a feel for what expectations we should have about the portfolio. 

Furthermore, backdating is useful to determine a suitable choice of benchmark. Without a benchmark for comparison it is not possible to evaluate the performance of a portfolio. For instance, say the value of the portfolio falls by 2% over the next month. A stand-alone absolute figure like this does not inform us on whether that is a good or bad result. If other comparable portfolios had lost 5% over the same period, even this loss could indicate a well managed fund.

Below is the backdated performance of the portfolio against the Bloomberg Global Investment Grade Corporate Bond Index (BCOR). This portfolio was chosen since it holds the most diversified holdings among the indices considered, with considerable holdings across each of the countries included in the client's portfolio.

Looking at these return graphs performance shows that there is a high degree of correlation between the two funds (in fact that correlation is 0.89, as shown in the statistical summary below). This is a good sign as it seems the benchmark chosen is an appropriate one. While both funds showed solid performance, over the past year the returns of the constructed portfolio fell short of the benchmark by approximately 1%.

The attribution tab in Bloomberg can help break down the performance further:

According to the attribution results there was a large difference in returns attributable to currency exposure. It seems despite issues from a wide selection of countries, the benchmark contains mostly (~60%) bonds denominated in USD. Since the USD performed comparatively well over this period the benchmark achieved 5.15% greater returns from exchange rate exposure (performance is being measured in pounds sterling).

As for the allocation of stocks among sectors and the selection of individual stocks, Bloomberg's analysis is very favorable of the constructed portfolio. In fact, it outperformed the benchmark by a significant 3.16% in terms of selecting individual stocks.

Looking at the statistical summary above, it also seems that the constructed portfolio experienced lower volatility in its returns. Running a simulation analysis, supports this evidence further. The 5% Value at Risk (daily) for the portfolio is simulated at £5,150 compared to £5,706 for the benchmark index.

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