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We include fixed-income securities in portfolios for three
major reasons:
- as an ingredient in a specific asset/liability matching
strategy,
- to find the appropriate risk/reward balance for a particular
client, or
- to control volatility and enhance income in a balanced
portfolio.
In the fixed-income portion of portfolios we manage, we
are guided by the following convictions:
- Domestic debt markets are highly efficient by virtue of
their size and liquidity and the involvement of professional
investors equipped with excellent information systems. Non-U.S.
markets are less efficient, thus offering opportunities
for profit, but currency, liquidity and transaction cost
considerations reduce the appeal of those markets for U.S.
investors.
- U.S. Treasury and Agency notes and bonds are the benchmarks
against which all fixed-income alternatives should be measured.
- Returns above those of the benchmarks can be earned only
by taking some combination of risks, typically involving
interest rates, credit quality, premature call or prepayment,
currency, or "event risk." Depending on the client,
some of these risk exposures may be acceptable, others not.
- Risk should be incurred only when reward potentials are
sufficiently attractive to justify taking the risk.
- Tax-exempt bonds should be considered when of satisfactory
quality and when justified by the client's anticipated tax
bracket over a reasonable investment horizon. Higher transaction
costs require that these bonds not be traded, but rather
be held to maturity. They also carry the obligation to diversify
and bring added complexities related to the Alternative
Minimum Tax, but nevertheless can be rewarding holdings
under suitable circumstances.
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