Archive for the ‘bonds’ Category

What is a proper credit orientation February 23rd, 2010

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76Win-Win Orientation

If you scored low in this attribute, you probably use a win-lose style of conflict resolution and problem solving. This is especially true if you are a competitive person. Competitive conflict resolution and problem-solving techniques, by their very nature, are designed to help one side meet its needs. In a partnership, this is destructive behavior. If you scored high in this attribute, you are more likely to use a winwin style for conflict resolution and problem solving. People with this style generally have a higher ability to trust and feel more comfortable being interdependent with others.

Ability to Trust

If you scored low in this attribute, you tend to have a low ability to trust that people will do what they promise. Certain people do condition us to expect the worst of them. But when we get caught up in that kind of thinking, a series of cascading events can actually set up the expected disappointment. People who have a low ability to trust also tend to have a high need for independence, rely on a past orientation in their decision-making style, and use a win-lose style of conflict resolution and problem solving. If you scored high in this attribute, you generally trust that people will do what they say. In turn you may tend to use a future-oriented decision-making style, be comfortable with interdependence, and be predisposed to using a win-win style of conflict resolution and problem solving.

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A more favorable environment for credit November 19th, 2009

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With the decline of default rates and credit blowups in 2003 and 2004, more and more portfolio managers have realized that the concentration on idiosyncratic risk yields unsatisfactory results in a more favorable environment for credit. Increasing allocation and spread duration may sometimes not be enough to outperform the market during a rally. The use of betas can help to correct this error. The concept originally stems from the equity markets where it is used to describe the portion of the variation in asset returns that is due to market fluctuations. In credit markets beta analysis should only be applied to credit returns, that is the part of a bond’s return that is solely due to changes of the spread versus the swap curve. For a well-diversified portfolio systematic risk, which is captured by the beta, is the major part of credit risk. On a single issuer basis, however, idiosyncratic risk prevails, especially for lower rated credits. Since market data for individual bonds contain a lot of noise, regressions to obtain betas versus the market index should also be done on the sector level. If the portfolio manager is bullish on the credit market, he will tend to overweight higher beta sectors and issuers. This methodology adds a third dimension to the process of tactical positioning, supplementing the decisions on the sector allocation and spread duration.

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Shortcomings of the credit curve November 13th, 2009

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A way to avoid the shortcomings of the above-described credit curve trade are duration-neutral box trades. Essentially, the trade consists of two legs. The investor buys the long-term bond of issuer A and sells the longterm bond of issuer B. Additionally, he sells short-term bonds of the first issuer and buys short-term bonds of the second issuer. Consequently, the trade benefits from a flattening of issuer A’s credit curve and a steepening of issuer B’s credit curve. This trade, of course, can be constructed to be duration neutral. Yet, there are myriad possibilities to do this. Assuming that no borrowing and leveraging are allowed the duration of the combined trade will always lie between the durations of the second shortest and second longest bond. While the position is insensitive to changes in the yield curve, its performance in general depends not only on changes of the credit curve but also changes of the level of spreads.

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Flat credit curves imply stable spreads November 5th, 2009

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It is important to note that upward sloping credit curves imply a widening of spreads, flat credit curves imply stable spreads and inverse credit curves imply tightening spreads. Again, as with government bonds implied spreads differ from expected future spreads. Longer term corporate bonds should not only contain a premium that compensates investors for accepting higher price volatility, but also for taking on additional credit risk.

A second observation with respect to forward credit curves is related to the slope: The steeper a credit curve is, the larger is the implied spread widening. If the spread widens less or more than indicated by forward spreads over the holding period, certain bonds will perform better than others. Portfolio managers who have a strong view on the spread changes they expect for an issuer’s bonds may benefit from this fact. If, for example, they expect the bonds of an issuer with an upward sloping credit curve, as France Telecom, to widen less than implied by forward spreads, they would prefer to own longer term bonds, because the additional carry should overcompensate the capital loss due to the expected spread widening.

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