The information and illustration presented in the scenario tool is for hypothetical and illustrative purposes only. Results may not represent the experience of individual investors, and should not be construed as tax or legal advice. An investor should consult a financial and/or tax professional concerning his or her specific situation before making any financial decisions. The use of tools cannot guarantee performance. Any references to future returns should not be construed as an estimate of the results a client portfolio may achieve.
Yields, cumulative income and total return shown do not reflect the effect fees imposed by an investment manager nor does it reflect the impact of taxes. Fees and taxes will reduce the value of a client’s portfolio. Past performance is no guarantee of future results.
The simulations presented do not represent the results that any particular investor actually attained. The information presented is based, in part, on hypothetical assumptions entered by the user. No representation or warranty is made as to the reasonableness of the assumptions made or that all the assumptions used in achieving the returns have been stated or fully considered. Simulated results have many inherent limitations and no representation is made that any account will or is likely to profit similar to those shown in the scenarios. Actual performance results may differ, and may differ substantially, from the simulations. Changes in the assumptions may have a material impact on the hypothetical results presented.
Risks: Investments in corporate debt obligations are subject to the risk of non-payment of scheduled principal and interest. Changes in economic conditions or other circumstances may reduce the capacity of the party obligated to make principal and interest payments on such instruments and may lead to defaults. Such non-payments and defaults may reduce income distributions. The value of a debt obligation also may decline because of concerns about the issuer’s ability to make principal and interest payments. In addition, the credit ratings of income securities may be lowered if the financial condition of the party obligated to make payments with respect to such instruments changes. Credit ratings assigned by rating agencies are based on a number of factors and do not necessarily reflect the issuer’s current financial condition or the volatility or liquidity of the security.
Scenario Assumptions: All returns and yields are gross of fees and taxes. The hypothetical laddered portfolio is defined by user inputs (i.e. the maturity start and end year in the tool above) where an equal investment is allocated to each maturity from “x” to “y” years. The length of the ladder “x” to “y” is determined by the “Ladder Range” input. As the first year bond matures or rolls down outside the specified ladder range and needs to be sold, additional bonds are purchased on the furthest rung of the ladder using those proceeds. It is assumed that bonds are purchased at par where the coupon equals the yield.
Yield curves are calculated using the Nelson-Siegel model to build the corporate spread curves. It is a four-parameter formula that can account for the many shapes observed in the curvature of term structures. While this approach was originally applied to building traditional rate-maturity curves, we borrow the model and simply apply it to fitting OAS-duration curves.
The universe of bonds is prescreened from the relevant index universe (e.g., US corporates, AA-rated). While ratings are updated only monthly for purposes of selecting constituents for rating sub-indices, they are updated daily for purposes of determining observations for rating category corporate spread curves. Next, the median OAS and the average of deviates (the absolute difference of the OAS and median OAS) are calculated. A spread outside the band of four-times the average of deviates is excluded from the fitting. Finally, the parameters are adjusted to achieve an optimal solution by minimizing the sum of the square of the differences between the bonds and the fitted curve. The bonds are duration-weighted for purposes of calculating the best fit. In addition, depending on the curve, the bonds may be additionally market-weighted, or equal-weighted.
Once the OAS-duration curve is fit, it is just a matter of overlaying it on the underlying government curve to generate the resulting spot and par-coupon corporate yield curves. Since the corporate par curve is a function of maturity, an iterative process is applied to guarantee the resulting par curve is consistent with the OAS-duration curve. The iterative process adjusts the corporate par coupon rate at each maturity point to match the OAS-duration curve.
The “Ladder Quality” input determines which yield curve is used. These are approximate yields and may not represent an investor’s actual portfolio yield. A “BBB” and “A” rated Ladder may contain bonds that have higher ratings (i.e. the minimum credit rating selected in the tool above) than the minimum rating of that specified Ladder. Changes in purchase yields over the life of the laddered portfolio are determined by modifying the original purchase yields by the “Interest Rate Shock” inputs. For example: If the user chooses a 2% rise in rates over 5 years, the model will assume rates rise .40% per year each year for 5 years for all rungs of the ladder. The model then assumes rates stay flat in the years following. Maturing and sold proceeds are reinvested at the new adjusted yield in the longest rung of the Ladder. Each rung has a specific duration. The “Starting Average Duration” (i.e. the starting average duration in the tool above) is the average duration of the portfolio. The duration for each rung is derived using a modified duration calculation. The “Starting Average Maturity” is the average maturity of the portfolio. The “Starting Yield to Worst” is the average yield of the portfolio. The change in yield is determined as follows: After one year, what was originally an “x” year bond will be an “x”-1 year bond with a yield equal to the original “x”-1 year yield, plus or minus any yield change applied from the model’s Interest Rate Shock inputs. The annual total return of the laddered portfolio is calculated by adding the average annual coupon income from each bond and the weighted average of the change in price of each bond. The change in price of each bond is calculated by subtracting the beginning price from the ending price divided by the beginning price. The bond prices are derived using the price function assuming redemption at par, semiannual coupons and are calculated off of the change in yields as detailed above.