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Yield curve strategies
Fund managers can earn above average returns by taking advantage of forecasted movements of the yield curve based on distribution of maturities. When yield curve changes its level as well as shape, it can have a huge impact on the portfolio returns. Some of these strategies are:
- Bullet strategies: Here, the portfolio consists of bonds with a single maturity. The fund manager may advise the investor to buy a high yield bond with single maturity if high yield is the investor's prime motive. Though the reward is higher here, interest rate volatility may be a risk here. If the interest rate of the bond falls, it will result in a capital loss to the investor. Hence, interest rate movement must be the top consideration here before taking advantage of a portfolio concentrated at one point in the yield curve.
- Barbell strategies:The portfolio is structured so as to consist of bonds which have very short or very long maturities. Thus here, the portfolio is concentrated on two far off points on the yield curve so as to take advantage of the very short term yields and very long term yields.
- Ladder strategies: In this strategy, the portfolio consists of bonds which have staggered maturities. In other words, spacing of maturities is done. This strategy is very appropriate when future movements of interest rates cannot be forecasted as maturity spacing ensures that the portfolio has bonds which are maturing in any market conditions. This is a popular strategy when there are great fluctuations in the interest rate. It helps the portfolios to take advantage of rising rates and subdues the effect of lower rates. Different maturity bonds are evenly distributed in the portfolio. The cash flows coming in from a currently maturing bond is typically invested in bonds with longer maturities. This strategy has an added advantage of minimizing the reinvestment risk.
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