Duration Targeting for Fixed Income Portfolios

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I came across an interesting paper that formalizes the benefits of duration targeting in managing Fixed Income portfolios. Here’s a podcast interview with one of the authors Martin L. Leibowitz. The one neat result of his research, as he describes it, is that: after a period of 2 x targeted duration, the portfolio’s annualized yield will end up with what you started with irrespective of the volatility in between.

I want to quickly check this result so created and back-tested a portfolio using PORT in Bloomberg. I was really interested to see if a Duration targeting portfolio does outperform a “buy and hold” variety. This was not meant to be a holistic result verification, but a quick trial/check. So I created two portfolios

Port A] Duration Targeting Portfolio.  Used PORT Optimization and Back-Testing to arrange this portfolio. Targeted Duration was 5years. So I had to analyze over a 10 year period. I selected 2010-2019-end.

Port B] Buy and Hold Portfolio comprising of just 4 bonds starting with equal weights: AON, CVS, LLY and WMT.

·         Attempted to get bonds that were close to investment grade

·         ++ Issue date before 2010

·         ++ Maturity after 2024 with more that 100 Million in outstanding balance.  

Screening parameters for Port A: Aimed for near investment grade bonds with over 100Million amount outstanding and relatively liquid to minimize transaction costs (LQA Liquidity Score > 45). I used Bloomberg SRCH function, and then funneled this SRCH results in the “Security Universe” for PORT Optimization & Back-Testing.

Portfolio optimization constraints: Port A was designed to minimize total risk ++ targeting duration between 4.5 to 5.5, and with bonds in SRCH universe stated above. I further insisted that we have at least 5 funds in the portfolio and the minimum weight for each to be 0.5%. The optimizer had a difficult time finding solutions – maybe I should have expanded my trade universe. So I relaxed the duration in this case with a trade-off of 1.

Observations: In this case the “Buy-Hold” portfolio outperformed the Duration Targeting portfolio as of December 31st 2019 as indicated by the plots below. 





 

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