Recent trends shape Stephens' investment strategies.
Executive Vice President and Fixed Income Strategist Bill Tedford has been managing this portfolio since inception--providing tremendous consistency in strategy, philosophy and performance. Below are highlights from a recent discussion with Mr. Tedford regarding the firm's investment strategy in light of recent inflationary trends.
Q: How do you determine the inflationary trends upon which you base your investments?
A: The Federal Reserve monetary base is the best indicator of future inflation, and therefore, analysis of the base is essential to the index. We begin with the monetary base number and, after smoothing out its data with a three-month moving average, we compute the trailing 12-month rate of change. That number will have an impact on inflation approximately two years into the future. It is important to note that the monetary base is not the sole determinate of inflation. Inflation is strongly influenced by significant changes in off prices. Oil prices do not have a two-year time lag like the monetary base--oil has a more concurrent impact. Therefore we focus our efforts on building scenarios based on oil prices going up, down or staying constant. We run our formula forward and it shows us the direction in which inflation is likely to trend.
Q: In this inflationary environment, what government bond vehicles would you consider?
A: We would recommend purchasing a one-year or two-year Treasury. Much press rhetoric praised the benefits of inflation-protected vehicles in the current market, but we disagree. If interest rates increase, then we should see an increase in the interest paid on Treasury Inflation Protection Securities (TIPS). This would decrease the value of TIPS purchased now.
For example: If an investor buys a 10-year TIPS bond that pays 2 percent plus inflation and then rates rise so that 10-year TIPS are paying 3 percent plus inflation, the market value of the investors original purchase would decline by over 8 percent. For that reason, we are not recommending longer maturity bonds or TIPS.
Q: What are the duration and maturity parameters of SCM's bonds investments? How does market volatility affect bonds in the portfolio?
A: Unconstrained by specific parameters, we change the portfolio's composition when our monetary model indicates impending shifts in interest rates. Securities' durations and maturities will vary longer or shorter during certain market cycles. We are a very pro-active management team, making every attempt to determine variations far in advance of new interest rates. This portfolio flexibility has served us well in combating the negative effects of market volatility.
We do not purchase maturities of longer than 10 years because we recognize that the longer the maturity, the greater the impact of volatility. Our value proposition is to provide investors with less volatile bond portfolios that achieve superior returns to those of long maturity portfolios. We get plenty of 'bang for our buck' going out an average maturity of seven years.
Q: Why is portfolio strategy solely focused on government bonds?
There are many strategic advantages to a portfolio of this nature. We have AAA portfolios that are not affected by credit risk. By selecting non-callable securities, we ensure that our bonds have positive convexity and can maximize gains. In the most basic terms, AAA government bonds allow us to capture higher results with less risk, which is appealing to all investors.
Q. What is the biggest challenge in managing government bonds?
Many people are under the misconception that interest rate changes are random events. However, we have disproved this theory by building a 15-year audited track record of performance based on our forecasting strategy. Our ability to accurately assess interest rate changes stems from the collective experience and knowledge of Stephens' Fixed Income Executive Committee, which meets daily to discuss market trends.
Q: Undoubtedly, SCM's forecasting model has been effective as evidenced by your performance record. How have you managed to outperform the Lehman Aggregate and Intermediate Government indices over long periods?
A: We have been applying our strategy for over 22 years. When our model forecasts a decline in inflation, we lengthen the maturity of our bond portfolios to benefit from a decline in interest rates (and vice versa). This strategy has enabled us to add significant returns above the benchmark indices over the past 15 years.
For more information, please contact a representative from Stephens Private Client Group or Stephens Capital Management at: 501-377-2000.
This article was prepared for informative purposes only and is not an offer to buy or sell any securities. Information contained in the article was derived from sources considered reliable, but has not been independently confirmed or verified. The opinions expressed are the personal opinions of the author, they do not necessarily reflect the opinions of any other person or entity, and they are subject to change without notice. Past performance is no guarantee of future results.
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|Title Annotation:||Special Advertising Section|
|Date:||Oct 4, 2004|
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