Tactical Management of Credit-Quality Weightings by Bond Funds

7/30/2019 Tactical Management of Credit-Quality Weightings by Bond Funds

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Tactical Management of

Credit-Quality Weightingsby Bond Funds

George Hoffmann

University at Albany


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Objective of the Study

To determine if active bond portfolio management

outperforms passive management

o Active/Passive management: degree of credit quality weighting changes

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Primary Hypothesis

A relation exists between active bond portfoliomanagement and performance.

H1: active portfolio management outperformspassive management.

o R(Active Bond Portfolios) > R(Passive Bond Portfolios).

o SD(Active Bond Portfolios) < SD(Passive Bond Portfolios).

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Motivation for the Study (2) Carty and Fons (1993)

o Measuring Changes in Corporate Credit Quality Short-term ratings have a strong correlation with the business cycle.

Concept of ratings momentum.

Sterling and Fridson and Kong (2009)o Return Dynamics of Distressed Bonds

White (2010)o The Credit Rating Agencies

Role of credit ratings in portfolio management and likelihood of the lenderto pay back debt.

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Data Source Source: PSN Database

Identify bond portfolios and the credit ratings ofholdings

Years: 1983-2011o Years of chosen sample: 1995-2011

Nature of data:o Credit rating weights and their changes by year

o Monthly performance: return and return net of benchmark

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Characteristics of the Data

The role of credit rating assignments grew from2001 to 2011.

Displays impact of the credit rating agencies.

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

AAA 40 45 47 50 59 60 59 54 47 45 38AA 9 9 8 7 7 8 9 10 11 12 16

A 13 12 12 12 11 10 10 13 15 15 16

BBB 4 4 4 5 6 7 7 8 11 12 13

BB 2 2 2 2 4 5 5 5 5 5 6

B 2 2 3 3 4 5 5 5 5 6 6

Under B 0 0 1 1 1 1 1 1 2 2 2

Unrated 33 27 25 20 7 4 3 3 3 3 3

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14,975 original funds in PSNDatabase

2,906 with creditweighting data

1,856 for testperiod 1995-

2011

1,067testable

627 ActivelyManaged

Funds

440 PassivelyManaged

Funds

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Determining Representative Passive

Fund

Method of determination:o Benchmark: Barclays Aggregate Bond Index

o Tracking fund: Hartford Passive Bond Index Fundvery similar portfolio

composition to the Barclays Aggregate Bond Index, and data availablefor 1995 to 2011

o Monthly average return 1995 to 2011 for Barclays Index: 0.554%

o Monthly average return 1995 to 2011 for Hartford Fund: 0.553%

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Determining Active or Passive From original fundsfind credit rating weight deviation

between years

Compare to the benchmark by subtracting and taking theabsolute value

Average the percent deviations from the benchmark

Label high deviation as actively managed and low as

passively managed Use 5% average deviation as cut off level for active

AAA1995

AAA1996

20% 25%

Credit rating weight data Deviation between years

% Change AAA 1995 -1996

5%

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Performance Results: Monthly

1995-2011

None of the strategies significantly outperformed. Benchmark adjusted return difference of means:

o t-stat: 0.070 Raw return difference of means:

o

t-stat: -0.377 Actively managed fund returns had notably lower

standard deviation. Active managers control return variability through tactical credit

quality weighting

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Credit-quality Change vs. Performance

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Conclusion Fail to reject the null hypothesis

o H0: active portfolio management does not outperform passive

management.

Further Observations:

o Regression results: The more actively managed the portfolio, the lower isROR (to a point)

o Although their return is not superior, actively managed funds appear to

manage risk comparatively well.

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Tactical Management of Credit-Quality Weightings by Bond Funds

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