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Mike Spong Case ScenarioJennifer Simko’s fixed income portfolio has underperformed its benchmark, the Barclays Capital Aggregate Bond Index. Simko has asked her investment advisor, Mike Spong, to recommend a new fixed income manager. Spong has selected three fixed income portfolio managers for Simko to consider:- Mondavi Investment Partners- Smithers Associates- Vertex GroupSelected characteristics for each manager’s portfolio are provided in Exhibit 1.Exhibit 1Selected Portfolio Characteristics for the Benchmark Portfolio and Three Potential Fixed Income Managers, December 2009. Note that in Exhibit 1, the portfolio duration for the benchmark, Mondavi Investment Partners and Smithers Associates portfolios is 4.7. Portfolio duration for Vertex Group is 4.3.Spong makes the following statements to Simko regarding Exhibit 1:1. “Mondavi follows a full-replication approach where portfolio performance will match the fixed income benchmark’s performance. Mondavi’s portfolio sector weights, duration, convexity, and term structure match those of the benchmark. Smithers’s portfolio characteristics do not match the benchmark’s because Smithers has minor risk factor mismatches with the benchmark.”2. “Vertex’s strategy is to construct a portfolio that has significant mismatches with the benchmark with respect to duration, key rate duration, and sector allocations. Vertex also relies on proprietary interest rate forecast models to generate superior portfolio returns. Vertex’s objectives are to ensure that tracking risk is minimized and portfolio return exceeds benchmark return.”3. “Vertex evaluates potentials trades using total return analysis. Total return analysis assesses the expected effect of a trade on total portfolio return based on an interest rate forecast. For example, Vertex recently evaluated the expected total return for a single bond, with a beginning price of $103, a 5 percent semiannual coupon, an expected price at the end of one year of $102.5, and an annual reinvestment rate of 2 percent.”4. “Vertex also positions the portfolio to reflect the firm’s opinions on the direction of interest rates and credit spreads. Over the next six months Vertex is forecasting:l low and stable implied interest rate volatility, l spreads to narrow in all other spread sectors, l a positively sloped yield curve with short rates rising 25 basis points and long rates rising by about 75 basis points.” |
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