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Is there a good resource to read to discuss what types of allocations one should have in a diversified bond portfolio in terms of both credit quality and maturity? I'm curious what one might do for a $500,000 or $1 million portfolio.
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Longreits,

I'm sure there are many such suggestions floating around. I am also sure we could probably drive ourselves nuts trying to make sure we are spread across enough time, bond class and ratings. What I am not convinced of is that any particular asset allocation would be dramatically superior to several others.

Approach it like you do the equity side. How much diversification do you need that is likely to manage the risks that diversification mitigates? How many positions work for you? How many positions do you want to manage? Is the goal capital gains or cash flow?

On the equity side we have folks that run very focused portfolios with great success. On the equity side there are folks running successful portfolios with way above the "recommended" number of stocks. The switch to bonds is not a perfect translation but the general concepts still hold.

jack
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LONGREITS,

Allocation recomnedations for any asset-class suffer from three problems:

#1 They tend to be driven by erroneous assumptions about how markets work, e.g, the total garbage that is Modern Portfolio Theory.
#2 They tend to ignore the unique needs (and skills) of the investor.
#3 They tend to ingore "where the puck is going to be next."

Forget about reading anything. Instead, try doing some thinking. "What am I trying to accomplish? What is a feasible way to do it?" If you really do have $500k or better to work with, then there is almost nothing you can't do responsibly in the bond world. So the real question becomes, "How much work do you want to do to create and then maintain such a portfolio?" But you have already prejudiced your options by asking the question as you have. Instead, pose to yourself this problem. "I've got X dollars I could put to work. I'd like Y sort of return, with Z sort of risk/effort/assuredness. What are my choices?"

Think, think, think. That all this investing stuff is. "Hmm, This looks interesting. I wonder if I can make it work for me?" You've got good fundamentalist skills. So, basically, there's almost nothing in the conventional investing world you couldn't explore and turn into a success. That's an envious position to be. Use the opportunity wisely.

Think, think, think. What you do most want to do? What would be the most fun to do? What would be the most responsible thing to do? What choice offers the best combination of reward for effort, fun for effort, and no more than reasonable grief? It might be bonds. It might be something else. It might be two things, but I would strongly advice that you don't attempt three. And the advice that's typically given about "diversification" is a crock. What's needed is "risk-management" for which (and within which) diversification can be a tool. But focusing on the latter, to achieve the former, is letting the tail wag the dog.

If your interest and needs really do dictate that bonds are your path, then you need to ask yourself where we are in terms of the long-term trends. Unless you intend to trade from both sides of the market, the linked chart should suggest that you're very late to the party and you're likely to be fighting head winds for the next 20 years. http://finance.yahoo.com/echarts?s=^TYX+Interactive#symbol=^...

OTOH, pull charts for commodities and ask how long in the tooth they are by comparison, and then read the post by Quillpen and follow the links. In particular, pull the term sheet for the POS Commodity CD that Everbank is selling. Dump the data for each commodity into Excel and start asking yourself what they are really selling you and how easy it would be to do a responsible knock-off in which you set the floors and ceilings for yourself. http://boards.fool.com/laurora-piece-of-cake-lets-peruse-the...

In other words, would it be possible to create a synthetic bond that offered a modest but still reasonable return, while at the same time you average into the "normal" bond market as opportunities arise?

Charlie
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Charlie,

Thanks a lot for your thoughtful post. I take your words seriously as your experience and performance are both meaningful and impressive. I do feel I'm "late to the party" but also feel this is an incredible asset class full of opportunities, even if at certain times there are more opportunities than in others. I have invested exclusively in equities with some success, 9.97% compounded over the last five years, and right now equities and only equities are within my circle of competence. I'm trying to build my fixed income skill set in the coming years so I can be ready when the opportunity comes. I have started to run bond searches in my etrade account (which I got just to get quotes on corporates), and have started to read more and more about the subject.

I feel I'm very knowledgable in the handful of companies I invest, and hope to develop some similar fluency in bonds.

LONGREITS
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hey long,

depends on how geekie you are: google "fabozzi fixed income portfolio"

unfortunately because of the differences there is not much literature between the textbooks that usually cover the bond basics and the research papers that self medicate A type grad students.

because in FI the risks are better defined there are ways to manage the risks that equities gloss over. credit risk for example... the diversification of credit risk in equities is "16 or more stocks in different sectors." Where in the FI, if you do the same 16 names who has the greater default risk??? Equities! Yet, Never here of equities diversifying across the credit spectrum, even with the same available info.

If not so geekie - perhaps just picking a basic read (textbook) that talks about the risk management in FI and then drawing conclusion on how you would feel about exposure to each of the risks. Marcus, Kane & Brodie: Strong: Puhle: or up the geek scale Hull: White: Duffie:
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I do feel I'm "late to the party" but also feel this is an this is an incredible asset class full of opportunities, even if at certain times there are more opportunities than in others.

LONGREITS,

If getting into bonds is what you really, really, really want to do, then you'll make a success of it, because passion is the most important part of the equation. The technical skills are trivial, and you've got them.

I'm not going to give away proprietary material in public, but get a hold of me through PM, and I'll suggest some techniques you could explore that might help you ramp up faster than you're likely to do on your own.

Charlie
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Longreits,

If you are going to take a fundy approach then every company you research gets a bond and an equity sniff before it gets round filed or added to the port. Crunch the numbers and if "ew too expensive for equity risk" run an Etrade scan and see what the debt is trading for, does that pay you enough for the risk you are taking?

While you are waiting for a few fat pitches you will spin up pretty quickly. You can flip the process and scan the bonds screens and tag a list and if the debt is not attractive switch over and see if the equity is worth a trip.

My theory is that if you do your homework and legwork you are most likely going to buy the right quality priced at the right risk most of the time. It does not really matter if you hold X% of anything as long as your bottom up process told you it was a go. Buy enough of properly priced quality/risk and portfolio diversification takes care of itself. The real risk hedge is that you know what you bought, why you bought it and have bracketed its likely results. You are likely to win more often than you lose. A near 10% compound return over the last 5 years is quality equity work and the types of skills you are currently using cross over pretty well.

jack
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Buy enough of properly-priced quality/risk, and portfolio diversification takes care of itself. The real risk-hedge is that you know what you bought, why you bought it, and have bracketed its likely results.

Jack,

I threw in a couple of hyphens and commas, but your advice describes exactly the essence of the value game. If each purchase is thoughtfully made and can stand on its own merits, then the whole will be robust to dangers and, likely, as maximally-profitable as it is reasonable to expect.

Charlie
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