The Theory and Practice of Investment Management: Asset Allocation, Valuation, Portfolio Construction, and Strategies, Second Edition

PORTFOLIO PARAMETERS

Ultimately, the portfolio manager must make investment decisions. In practice, this requires the buying and selling of bonds and bond surrogates, and currencies and currency surrogates to create a meaningful portfolio that reflects the desired target parameters. Among the most important parameters are the portfolio’s country duration and expected cash flow distribution (yield curve exposure), currency positions, convexity, sector, and credit allocation. These parameters may either be unique or so interrelated that the purity of the choices may become obscured. Nevertheless, the portfolio’s definition is within these decision parameters. (In the abstract, however, an efficient and meaningful portfolio can be achieved by merely placing allocations amongst the various market subindexes in combination with a macrocurrency allocation scheme.)

For example, the country-specific duration of a portfolio is the most potent source of forecast expression. Large relative positions in currencies are equally important. Extreme duration choices, relative to a market benchmark, represent an expectation for substantially higher or lower interest rates in any given fixed income market as well as a high degree of confidence in the outcome. Implicit within an extreme duration forecast is the expression of expectations for substantial changes in the volatility of interest rates. Similarly, extreme variation in currency composition relative to the benchmark represents an expression ...