questions everyone should ask their bond fund managers but … · 2019-07-18 · examples are for...

Questions Everyone Should Ask Their Bond Fund Managers But Never Do

MAY 15, 2019 Presented by:Bryan Whalen, CFAGroup Managing DirectorPortfolio Manager Fixed Income

5/1/2019 1

Question #1: “I see the market value percentage of each sector, but what about the spread duration?”

Spread Duration: The Sensitivity of a bond’s price to changes in its credit spread

Yield

3.0%

2.5%

Credit Spread of+0.5%

Duration5 Yrs

Scenario #1

Examples are for illustrative and educational purposes only and do not include transaction or management fees. The examples shown are not intended to be investment recommendations.

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0.5%

Yield

3.0%

3.5%

4.0%

2.5%

Duration5 Yrs

+1%Rate Shock

Bond Price: $100 $95


Scenario #2 – Interest Rate Shock


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Bond Price: $100 $97.5



Scenario #3 – Credit Spread Shock

Yield

3.0%

3.5%

2.5%

0.5%

Duration5 Yrs

1.0%

+0.5% CreditSpread Shock


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Look Under the Covers!

Bond Fund A

Price: $10.00Average Duration: 5.0 yrsSEC Yield: 3%

Sector Analysis

Cash Equivalents 5%U.S. Governments: 20%Corporates: 35%Commercial MBS: 10%Asset Backed: 10%Mortgage Backed 20%

1 Year Return: 2%

Identical Funds?

Similar Risk?

Manager B Stronger Than A?

Bond Fund B

Price: $10.00Average Duration: 5.0 yrsSEC Yield: 3%

Sector Analysis

Cash Equivalents 5%U.S. Governments: 20%Corporates: 35%Commercial MBS: 10%Asset Backed: 10%Mortgage Backed 20%

1 Year Return: 5%

Examples are for illustrative and educational purposes only and do not include transaction or management fees.

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Why?

Bond Fund B SignificantlyUnderperforms Bond Fund A

Spread Duration =Spread Duration =

Bond Fund A

Price: $9.8

Bond Fund B

Price: $9.3Credit Spreads

Immediately Widen +100 Basis Points or 1% -7%-2%

7.0 Yrs2.0 Yrs


Look Under the Covers!


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Question #2: “Now that I know the spread duration of a bond/sector/fund, I know how its price will change when its credit spread significantly changes, but how likely is that to happen?”

Apples-to-Apples?

Listen and ask for terms like D.T.S., Adjusted Spread Duration, and Beta-Adjusted Spread Duration

Not All Spread Durationis Created Equal

Spread Duration 5.0 5.0 5.0 5.0 5.0

Examples are for illustrative and educational purposes only and do not include transaction or management fees. The companies shown are not presented as investment recommendations.

Disney Ford General Electric

CaesarsPalace

JP Morgan

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Question #2: “I know how a bond’s (sector, fund etc.,) price will change when its credit spread significantly changes, but how likely is that to happen?”

Spread Duration

Credit Spread

5.0

+50

5.0

+250 (5x)

5.0

+150 (3x)

5.0

+90 (1.8x)

5.0

+300 (6x)

Examples are for illustrative and educational purposes only and do not include transaction or management fees. The companies shown are not presented as investment recommendations.

Disney Ford General Electric

CaesarsPalace

JP Morgan

5/1/2019 8

Question #2: “I know how a bond’s (sector, fund etc.,) price will change when its credit spread significantly changes, but how likely is that to happen?”

Don’t Forget To Ask About Securitized Products

A Good Question to Start With: What % of each sector is not guaranteed/wrapped by the U.S. Government AND are not the senior-most bonds in their respective capital structures?

100%

30%

20%

0%

$100 of 1st Lien Commercial Mortgages

70% Average Loan-to-Value Ratio

10 Yr Interest-Only Balloons

Raw Material (Assets) Finished Goods (Liabilities)

Rating Agency Expected Loses

Today

Rating Agency Expected Loses

Tomorrow?

70% AAA +60

10% (Jr.) AAA +100 AA +130A +170

BBB +275B Piece 15%


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Question #3: “I see the leverage stated as 0%, so the fund is not borrowing any money, but what is the implied leverage?”

The growth of non-cash instruments such as TBA’s (Mortgage-backed Securities), Futures, Forwards, and Credit Default Swaps (CDS) make it very difficult (sometimes impossible) to understand a fund’s true risk exposure.

Classic Example – “Leveraging” a Fund’s TBA Exposure

Scenario #1 – Unlevered

TBA’s (To Be Announced) are commitments to buy or sell an Agency MBS at a predetermined future date. Funds often “roll” these commitments every month enabling them to use the cash elsewhere.

+ =Long $100 Notional of Fannie Mae 3.5% 30 Yr TBA’s “Rolled”

Every Month

$100 Cash

$100 of Fannie Mae 3.5% 30 Yr

Mortgage-backed Securities

Bond Fund A Bond Fund B


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Scenario #2 – “Levered”

Memory Lane...

+

Instead ...

Long $100 Notional of Fannie Mae 3.5% 30 Yr TBA’s “Rolled”

Every Month

$100 of High Yield Floating Rate Bonds

$100 of High Yield Floating Rate Bonds

$100 of “AAA” Subprime


$100 of Fannie Mae 3.5% 30 Yr


Bond Fund A

2008

Bond Fund B

Question #3: “I see the leverage stated as 0%, so the fund is not borrowing any money, but what is the implied leverage?”


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Yield

3%

6 Yr

AverageDuration

Duration

CASH

FLOW

Yield

3%

6 Yr

AverageDuration

+1%RateShock

Duration

CASH

FLOW

+1%

Yield

3%

6 Yr

AverageDuration

Duration

CASH

FLOW

Yield

3%

6 Yr

AverageDuration

+1%RateShock

Duration

CASH

FLOW

+1%

Yield

3%

6 Yr

AverageDuration

Duration

CASH

FLOW

Yield

3%

6 Yr

AverageDuration

+1%RateShock

Duration

CASH

FLOW

CASH

FLOW

+1%

Benchmark Bond Fund A Bond Fund B

Question #4: “I see the fund has the same duration as the benchmark but is the curve positioning neutral as well?”

+1% ParallelRate Shock

-6% -6% -6%

Scenario #1


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Yield

3%

6 Yr

AverageDuration

+1%

Duration

CASHFLOW

Yield

3%

6 Yr

AverageDuration

Duration

+1%

CASHFLOW

Yield

3%

6 Yr Duration

FLOWCASH FLOW

+1% AverageDuration

Benchmark Bond Fund A Bond Fund B

Question #4: “I see the fund has the same duration as the benchmark but is the curve positioning neutral as well?”

-3% -3% -2.5%

Scenario #2 – Yield Curve Inversion

3M 6m 1Y 2Y 3Y 5Y 10Y 30Y4.0

5.0

6.0

7.0

8.0

Yiel

d %

Change

Maturity

Long RatesUnchanged

Short RatesRise +1%

U.S. Treasury Yield Curve (6/1/2000)

U.S. Treasury Yield Curve (6/1/1999)


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A Fund’s Reported Convexity Should Incorporate All “Short Vol” Positions

Question #5: “Has the fund sold any options and if so, what is the annualized income benefit to the fund?”

Dangers of “Short Vol” Overlays in Core Bond Portfolios

One Popular Options Strategy For A $100 Bond Fund in 3 Simple Steps

Sell $25 notional of an at-the-money, 1 month CALL option on the U.S. 10 year note monthly

Sell $25 notional of an at-the-money, 1 month PUT option on the U.S. 10 year note monthly

Collect approximately 100 basis points (1%) of annualized premium

1

2

3

2.35

2.40

2.45

2.50

10 Yr Yield

Prof

it/Lo

ss (b

ps)

2.55

2.60

2.65

2.70

2.75

2.80(0.10%)

(0.05%)

0.00%

0.05%

0.10%

0.15%

0.20%

0.25%

0.30%

0.35%

0.40%

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+0.23%2.47

-0.06%

Cumulative Profit & Loss Vs. U.S. 10 year Note YieldShort a Straddle

Fund’s Duration Difference vs. Benchmark

is 0 (no over/underweight)

Fund’s Duration is 1 Year Less Than the

Benchmark Due To Options Strategy


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Some Concluding Thoughts...

There is no free lunch! If a fund is yielding and/or returning significantly more than the benchmark, the fund is taking risk somewhere in the portfolio

It’s Your Job to Find Out Where...

Answers to all of these questions may not paint the complete picture but they will get you close

Enhance your due diligence with an analysis of daily NAV volatility during turbulent times

The only bad answer to any of these questions is no answer at all

4

1

3

2

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This material is for general information purposes only and does not constitute an offer to sell, or a solicitation of an offer to buy, any security. While the information and statistical data contained herein are based on sources believed to be reliable, we do not represent that it is accurate and it should not be relied upon as such or be the basis for an investment decision. The information contained herein may include “forward-looking statements.” Due to numerous factors, actual events may differ substantially from those presented. TCW assumes no duty to update any for-ward-looking statements or opinions in this document. Any opinions expressed herein are current only as of the time made and are subject to change without notice. Past performance is no guarantee of future results. © The TCW Group, Inc. 2019. All rights reserved.

The information provided in this communication is solely for educational purposes and should not be construed as advise or an investment recommendation. Fidelity Investments is a separate company, unaffiliated with TCW. There is no form of partnership, agency affiliation, or similar relationship between TCW and Fidelity Investments, nor is such a relationship created or implied by the information herein. Fidelity Investments has not been involved with the preparation of the content supplied by the TCW and does not guarantee or assume any responsibility for its accu-racy or completeness.

questions everyone should ask their bond fund managers but … · 2019-07-18 · examples are for...

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