Managing fixed income portfolios in-house using separately managed accounts requires expertise not often found with most investment advisory firms. However, it can provide flexibility and cost savings compared to mutual funds or exchange traded funds (ETFs). At Clearview we believe laddered bond portfolio strategies offer definite advantages when applied to the long-term “core” allocation of high-net-worth investors.
A bond ladder refers to the maturity structure of a fixed income portfolio. It is created by having an equal quantity of bonds maturing every six to twelve months starting with short bonds and increasing to the maximum maturity (typically ten years at Clearview). The proceeds from maturing bonds, depending upon availability, are reinvested within a year of the backend of the ladder.
The goal of a laddered bond portfolio is to deliver a continuing, front-end loaded series of coupon payments. As interest rates rise, maturing bond proceeds can be reinvested at higher rates. If interest rates fall, the prices of the bonds will rise (interest rates and bond prices move inversely) anchoring the portfolio while reinvestment rates decrease. Normally we buy bonds with the expectation of holding them to maturity and thus by necessity only buy high quality bonds. Lower quality bonds are far more likely to become stressed and receive credit quality downgrades.
The potential benefits to high-net-worth clients from this strategy include:
- A more custom tailored solution
- Control over the credit exposure
- Lower costs (mutual fund fees are avoided)
- A focus on maximizing each client’s after-tax returns
The minimum size of a laddered portfolio strategy at Clearview is $500,000. This account would normally hold between twelve and twenty individual bonds with block sizes ranging from $25,000 to $50,000.
Mutual funds and ETFs can still be used for tactical or satellite solutions or when the account asset size does not permit laddering. However, in our view mutual funds and ETFs fall short in core applications for several reasons including:
- Mutual fund costs can be high relative to return, especially in a low interest rate environment
- Mutual funds are mass marketed and do not provide a custom tailored solution
- Investors have no control over the quality of the bonds purchased
- Mutual funds and ETFs do not have a finite maturity compared to the stated final maturities of individual bonds
Advisors with the proper fixed income laddering expertise can provide high-net-worth clients the benefits described above as well as greater flexibility, transparency and costs savings. At Clearview, we have been working with laddered bond portfolios for over thirty years. We believe that customized core solutions designed to improve after-tax returns are the better way to add value to client portfolios on an ongoing basis.