There are various kinds of bonds strategies which a person could adopt to get returns out of the bonds he would like to hold in the portfolio. These include:
<ul>
	<li>Pure Bond Indexing Strategy</li>
	<li>Enhanced Indexing by Matching Primary Risk Factors</li>
	<li>Enhanced Indexing by Small Risk Factors Mismatching</li>
	<li>Active management by Large Risk Factor Mismatches</li>
	<li>Full-blown Risk Factors</li>
</ul>
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Classification of Bond Indexing Strategies

It is a passive strategy, which tries to follows the weight age of index on a day to day basis. It is usually taken up with the idea of not underperforming the index, without actively handling the same aggressively. This is a follow-up strategy, with the least risk of underperforming the index. A pure bond index strategy may match that of some index that the investor may have chosen as a benchmark. But it may be remembered the same index itself may not necessarily be the one to offer optimal performance.

Typically, the advantages of applying pure bond strategy to manage bonds are that it carries very little or no tracking error compared to the index it follows. Also, the advisory and administrative fee is low and varies from 1 basis point to 20 basis points. The risk exposure remains contained at the level as the index.

However, the disadvantage of pure indexing strategy is that is logistically difficult to implement due to frequent change in strategies demanded. It may prove costly due to regular re-shuffle. It may also offer lesser returns than the index. Total returns depend on the reinvestment rate available on interim cash flows.

Pure Bond Indexing Strategy

In this kind of a strategy, the smaller funds/ individuals try to replicate a relatively fewer number of issues as used in <a href="https://financetrain.com/pure-bond-indexing-strategy/" title="Pure Bond Indexing Strategy">pure bond indexing</a>, without acquiring each issue in the index. Yet, they construct a portfolio by matching primary risk factors without acquiring each issue in the index. However, in such cases, once the portfolio manager tries to overlook more number of issues tracked by the index, the risk factor gets increased for tracking error. The manager tries to maintain major primary issues like duration by leaving the same on index, but tries to take some other factors which he could control actively.

The advantage of following an Enhanced Indexing Strategy is that the same is less costly to implement, and offers a higher return, at the discretion or intelligence of the portfolio manager. Simultaneously, it also offers the leverage of maintaining the primary risk factors determined by the index.

However, the dark side of following this kind of a strategy is that it increases the tracking error possibility, once the manager starts taking them into his hands. Apart from same, the management fee is typically higher, and is worthwhile, only if it offers higher returns.


Enhanced Indexing Strategy - Primary Risks

This strategy allows leverage for minor mismatches in the risk factors except <a href="https://financetrain.com/what-is-macaulay-duration/" title="What is Macaulay Duration?">duration</a> to tilt the portfolio in favour of particular areas of relative value like sector, term, structure, quality and call risk etc. In this kind of a <a href="https://financetrain.com/classification-of-bond-indexing-strategies/" title="Classification of Bond Indexing Strategies">bond management strategy</a>, the portfolio manager applies some qualitative discretion or intelligence to compensate for administrative costs by following return enhancing policies, which may have higher risks.

By following this strategy, the managers could hope to enhance the returns of bonds, but keep the duration of bonds at same as that of an index. It also maintains exposure to the primary risk factors of index.

However, by following such a strategy, the tracking error gets enhanced and the exposure to risk also increases. Apart from this, the management fee is higher than that of <a href="https://financetrain.com/pure-bond-indexing-strategy/" title="Pure Bond Indexing Strategy">pure bond indexing</a>, or <a href="https://financetrain.com/enhanced-indexing-strategy-primary-risks/" title="Enhanced Indexing Strategy – Primary Risks">primary risk indexing strategy</a>. 


Enhanced Indexing Strategy - Small Risks

Active management of bonds is a strategy in which the active management risk factor does not match that of a bond indexing in terms of risk factors undertaken. 

It is usually followed for a smaller duration, and hence the management fee and transaction costs are much higher compared to other approaches already discussed.

The advantage of following this approach is that it reduces the manager’s restrictions, and offers the facility to tune the <a href="https://financetrain.com/what-is-macaulay-duration/" title="What is Macaulay Duration?">duration</a> of portfolio to the manager. It also offers room for increased expected return out the portfolio.

However, the drawback of using this strategy is that it increases the transaction costs as well as the management fee in most cases. Also, once the manager starts using more intelligence and discretion, his strategy is subject to higher degree of tracking error.


Active Fund Management - By Larger Risks

Full blown active approaches seek only return maximization. They are subject to large mismatches on any risk factor, including duration, in order to add value relative to the index. This is an aggressive style of portfolio management for bonds, where large <a href="https://financetrain.com/what-is-macaulay-duration/" title="What is Macaulay Duration?">duration</a> and sector based approach is followed by managers.

One of the attractions for bond managers in following this strategy is that the full blown active management offers the leverage of offering a relatively higher return out of bonds, albeit by undertaking some more risk. Another typical advantage of following the same is the freedom it allows the manager and has no specified time durations, which could vary.

However, on the dark side, the full blown active management involves a high degree of risk compared to <a href="https://financetrain.com/classification-of-bond-indexing-strategies/" title="Classification of Bond Indexing Strategies">bond indexing</a> or <a href="https://financetrain.com/enhanced-indexing-strategy-primary-risks/" title="Enhanced Indexing Strategy – Primary Risks">enhancing index strategy</a> or even active management. Apart from this, the tracking error also increases as the discretion of the manager rises and draws away from the pure indexing strategy. While the returns could be high by taking higher degree of risk, the management fees also tends to be much higher than other strategies.


Full Blown Active Management

Bond Portfolio Benchmarks

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COURSE

Bond Portfolio Benchmarks

Lessons

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