Systematic Fixed Income

CHAPTER 8Portfolio Construction Considerations

OVERVIEW

This chapter describes the portfolio construction process. There are many decisions that need to be made to convert your “signals” into portfolio positions. A successful systematic investment process needs to be excellent across many dimensions. These dimensions include: (i) breadth of investment themes covered, (ii) depth of measures across investment themes, (iii) choices in combining multiple investment themes and converting them to an expected return forecast, (iv) identifying a suitable set of fixed income securities that are appropriate for a systematic investment process (liquidity screening), (v) tracking error and risk modeling generally, and (vi) selecting sensible constraints to maximize risk‐adjusted returns while avoiding poorly compensated exposures. At the end of the chapter the reader should have a full appreciation of the challenges of portfolio construction, and hence understand the opportunity for skillful portfolio craftsmanship to improve the investor experience.

8.1 CHOICES IN THE INVESTMENT PROCESS (DESIGN AND INVESTMENT UNIVERSE)

Exhibit 8.1 is a simple visualization of the necessary ingredients for a successful investment process. There is nothing here that is specific to a systematic investment process since all aspects need to be implemented well for investment success for any investor. The previous three chapters have focused on Step 2 in the investment process: How do we rank the relative ...