A Conversation with the Fixed Income Management Team
We sat down with Mesirow Financial's Fixed Income Management team to ask about how they construct portfolios and the factors that guide their investment decisions.
| Q: | What is meant by a neutral duration posture? |
| A: | Duration neutral portfolio management entails working with each client to determine an optimal duration for the portfolio. The appropriate duration depends on factors such as the client's specific liquidity needs and overall ability to take risk, as well as the length of liabilities being funded. Once the appropriate duration is identified, the client's portfolio is managed to that duration. In this way, we closely align the price performance of the portfolio with that of the client's benchmark. In contrast, active duration management involves shortening or lengthening the portfolio based on an interest rate forecast. Because forecasting interest rates is notoriously difficult, this approach can result in extremes of performance, both good and bad - not the consistent type of return pattern most of our clients expect. Of course, the duration target can be adjusted over time as the client's investment situation changes |
| Q: | If you don't take bets on interest rates, how do you add value to your portfolios? |
| A: | By focusing on a larger number of smaller, manageable risks, we aim to provide our clients with a predictable pattern of competitive, risk-adjusted returns. Our philosophy is consistent with third-party research showing that sector rotation, yield curve management and security selection capture the bulk of incremental investment returns. Using these time-tested strategies, we aim to consistently outperform the benchmark over time while remaining duration-neutral throughout all interest rate environments. A key part of our process is independent, on-site, fixed-income credit and quantitative research and trading. We believe that this process allows us to achieve more consistent, reliable alpha over time. |
| Q: | Do you make any decisions about issue duration? |
| A: | Selecting the proper duration at the individual issue level is actually an integral part of our investment process. Although the duration of an overall portfolio matches that of the index, we determine the most efficient mix of individual fixed-income issues to get there. In a normal yield curve environment, our portfolios generally have a bulleted structure, where positions are concentrated in intermediate bonds. This bulleted maturity structure has tended to outperform over time. However, this strategy is not static. For instance, we may capitalize on an anticipated flattening of the yield curve by combining a weighted mix of longer and shorter issues whose average duration matches the target. In addition, we may include securities that have different features, such as very short duration floating rate coupons, zero-coupon STRIPS, or premium or discount bonds.
To determine the most efficient term structure to use to achieve our target duration, we conduct in-depth research and analysis of the yield curve. We closely monitor Fed policy and stay abreast of current economic cycles and interest rate trends. |
| Q: | How do you determine sector weightings? |
| A: | Most of our clients are long-term investors, such as retirement plans and endowment funds, that have little need for the instant liquidity of low-yielding government securities. For that reason, we generally underweight Treasuries and agencies, especially at the short end of the yield curve, in order to exploit the greater yield potential of sectors such as corporates, mortgage-backed or asset-backed securities. However, as sector spreads in the market can fluctuate dramatically over time, our decisions to under- or overweight sectors in the portfolio are made based on relative value opportunities. We conduct research on the economy, the Fed and the various sectors of the bond market from the standpoint of available return and risk to determine which sectors represent the greatest value in the current environment. We also consult with Mesirow Financial Chief Economist Diane Swonk for additional insight about the Fed and the economy as a whole. |
| Q: | How do you tailor portfolios to address a specific client's unique needs? |
| A: | Our highly-customized investment process begins with an understanding of each client's choice of benchmark index and unique investment guidelines. We work with a variety of institutional clients, including insurance companies, pension plans, endowments, hospitals and foreign companies. For each, we construct a customized portfolio that takes into account the institution's specific situation and requirements. This process includes factors such as a client's need for liquidity and safety of principal, their sensitivity to credit risk, volatility and tax consequences, their time horizon, including budget year, payout requirements , as well as any statutory guidelines governing maturity and issuers.
In addition, our process includes a high level of two-way communication with our clients. Regular reports provide clients with detailed information about the composition and performance of their portfolio relative to both the benchmark and their stated objectives, as well as all transactions made during the time period. Reports also include our current views on each sector and an economic outlook from Mesirow Financial Chief Economist Diane Swonk. Periodic conference calls and face-to-face meetings allow us to share our strategy and rationale with clients. These meetings occur as often as each client wishes, typically once or twice a year. |
| Q: | What kinds of monitoring do you conduct on existing portfolios? |
| A: | We continuously conduct comparisons of portfolios to their benchmarks and to the clients' investment objectives using several sophisticated third-party tools. Each week, the fixed income management team meets formally to discuss recent developments in the bond market and the various sectors. These steps help us determine what adjustments may be needed to continue to efficiently capture value in a changing market. All our portfolios benefit from ongoing research as strategy decisions are implemented across both new and existing portfolios. |
*The information contained herein should not be construed as a recommendation to purchase or sell any particular security or investment vehicle offered by Mesirow Financial. The information included has been obtained form sources believed to be reliable, but is not necessarily complete and its accuracy cannot be guaranteed. Any opinions expressed are subject to change without notice. Mesirow Financial Investment Management, Inc. and its affiliated companies and/or individuals may, from time to time, own, have long or short positions in, or options on, or act as a market maker in, any securities discussed herein and may also perform financial advisory or investment banking services for those companies. A complete list of composites can be made available upon request. Information is provided in U.S. dollar denominations.
It should not be assumed that any recommendations incorporated herein will be profitable or will equal past performance. Any stated performance results include the reinvestment of dividends and other earnings. The Mesirow Financial name and logo are registered service marks of Mesirow Financial Holdings, Inc. Investment management services offered by Mesirow Financial Investment Management, Inc., an SEC-registered investment advisor. Securities offered through Mesirow Financial, Inc. member NYSE, SIPC.
