dedicated portfolio

Investment Advice Based on Dedicated Portfolio Theory

IncomeClub provides investment advice applying Asset Dedication approach, which has a fundamental difference from traditional asset allocation. Asset dedication principals are based on  Dedicated Portfolio Theory.
Bond Investing Fundamentals

Dedicated Portfolio Theory

A Dedicated Portfolio has a very specific goal. It should be able to create a reliable and predictable influx of cash in the future.

Most investors will find that they have the best luck when it comes to creating a dedicated portfolio if they utilize fixed income securities that have a predetermined cash stream.

Some of the best options to consider include CDs (Certificates of Deposits) and individual bonds, and then holding onto these securities until they mature. The reliable stream of cash is generated from the interest payments, as well as the repayment of

The reliable stream of cash is generated from the interest payments, as well as the repayment of a face value of the bonds when they finally reach maturity.

How to Build Dedicated Portfolio

Investing with a dedicated portfolio is much different from other types of investing. The biggest difference comes from the fact that it should only consist of those bonds that have a fixed maturity date.

How is this a smart move for investors?

These bonds will have their face value when they reach maturity, even if there are price changes during the period in which you hold the bond. When your bonds finally reach maturity, you do not have to worry about losing capital – you will get the face value.

Take a moment to think about bonds’ funds. They do not have a maturity, which means that you do not have any protection for your investment if the interest rate rises.

Those who want less risk will always choose bonds that have a defined maturity date.

Academic Work in the Field of Dedicated Portfolio

Utilizing this approach to investing is one of the best and simplest methods of immunizing a portfolio in the event of rising interest rates, as proven by Martin L. Leibowitz. He was also the first one who called this type of investment a “cash-matching portfolio.”

Other experts over the years have come to agree with his theory, as it is proven time and again.

Leibowitz and Weinburger published a report in 1981 on contingent immunization, where they went into detail regarding how to mix active bond portfolios with immunization, all in the effort to create a reliable and known floor for the returns. Just five years later, in 1986, he published another paper, this one was in two parts, and it dealt with dedicated portfolios.

While Leibowitz may have been one of the early adopters, others entered the field and have added to the research on the topic of dedicated portfolios. Stephen J. Huxley, Ph.D. (University of San Francisco), published Asset Dedication along with Brent Burns, which was published in 2005.

See White Paper about Asset Dedication Approach from Huxley and Burns.

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A Dedicated Portfolio Advantages

One of the biggest advantages is that you will have a predictable cash flow when you use this method of a dedicated portfolio with bonds held to their maturity.

This is something that you simply won’t find with other types of investments. You already know the amounts of the coupon payments and the maturity payments when you are choosing the bonds, and this provides a high level of certainty.

Bond funds are not capable of doing this since they tend to have a large number of bonds, and most investors will not hold onto them until they reach maturity. Instead, they trade them. This makes the bond funds behave similarly to stocks, thus the unpredictability.

You will also have a lower market risk when you hold them to maturity. Even if there are shifts in the market, that volatility will not affect the investor.

This helps to eliminate a substantial amount of risk. When you use “Investment Grade Corporate Bonds” as a way to invest they can provide a better yield than inflation. It is possible to reinvest matured bonds to receive a higher yield during the inflation.

When using a dedicated portfolio properly, it becomes possible to generate a desired and known return on the investment. This is a far more passive form of investment than some might take, but it has proven to be very successful.

One of the other benefits is the cost savings. Since it is a passive type of investment, it means the investor will be paying far less to the brokers. Consider how much you would have to pay your broker when you are constantly making trades, for example.

Disadvantages of a Dedicated Portfolio

While a dedicated portfolio is certainly one of the best options for investors, and it does have plenty of advantages, it is also important to look at the disadvantages. This will give you a better idea of what you are in store for when you start to develop your own.

First, it can be difficult to create a high-quality dedicated portfolio for those who are new to investing.

You really need to understand bonds and different types of fixed income securities. Some bonds simply will not work well for dedicated portfolios. You can’t use callable bonds, as these are not going to create a predictable cash flow for you.

You will also need to understand all of the math that goes into optimization theory, so you know the best amounts to invest for each maturity, the different industries that work the best, credit risk ratings, and more.

In addition, you need to understand the risks of reinvestment and whether you should reinvest or not. For those who do not know much about these elements, it is best to work with someone who can help.

As you can see, the idea of a dedicated portfolio is sound for most investors out there today. You simply need to take the time to understand how to create a dedicated portfolio properly, or have someone who provides investment advice and who has a good reputation in the industry to help you.
Bond Investing Fundamentals