Is Your Fixed Income Strategy a Risk Reducer?

A multi-billion-dollar hedge fund managed by one of Wall Street's most powerful investment banks lost 30% of its assets in a single week in early August. Moody's and Standard & Poor's downgraded credit ratings on hundreds of mortgage-backed securities. The Dow Industrials plunged over 300 points on July 26 on record volume of 5.87 billion shares.

The recent fall in stock prices around the world has served as a reminder of the reason for which many investors hold a portion of their portfolios in fixed income securities. Many investors are wondering what effect the current turmoil in the credit markets is having on their fixed income portfolio.

If you are utilizing Jefferson’s Asset Class Portfolio’s the answer is "not much."

Our portfolios invest exclusively in high quality fixed income with maturities from one to five years. If our stategic partner, Dimensional Fund Advisors were a conventional money management firm, we might attribute this pleasing result to the wisdom of Dimensional's portfolio managers in predicting the turmoil in the mortgage market and adjusting the portfolio accordingly. But no such predictions were involved; the absence of mortgage-backed obligations (regardless of credit rating) simply reflects Dimensional's ongoing policy to exclude such securities and focus on obligations with predictable maturities in order to properly implement the shifting-maturity strategy.

If the primary purpose of fixed income, as we believe, is to dampen the sharp fluctuations of an all-equity account, it should be a dependable risk reducer.

As many investors are discovering, fixed income strategies with seemingly impressive positive returns may be vulnerable to impressive returns in the other direction.