Table of Contents
PGIM Fixed Income constructs and manages the strategy on the philosophy that diversified portfolios, built through the integration of credit research, quantitative research, and risk budgeting can achieve consistent returns in excess of the benchmark over time. The approach is centered around these bottom-up activities.
PGIM Fixed Income implements this investment philosophy is managed in accordance with a risk budget versus the Bloomberg Barclays U.S. Aggregate ex-Credit Index, which is unmanaged and represents securities that are SEC registered, taxable, and dollar denominated, and by seeking value from yield curve positioning, sector allocation, and subsector and security selection.
PGIM Fixed Income manages portfolios for the Strategy using a four-step process:
1. Develop Market Outlook
Portfolio construction begins with the development of a top-down Market Outlook. The Chief Investment Officer, Head of the Sector Teams, Chief Investment Strategist, Economist, and Heads of our Research Teams meet weekly to discuss the Outlook and prepare a formal assessment on a quarterly basis. The Outlook is a firm-wide assessment of likely economic and interest rate scenarios and relative performance of each fixed income sector. The Outlook plays a central role in helping us evaluate the appropriate levels and types of risk to assume across portfolios.
2. Construct Portfolio Using Outlook as Guide
The Portfolio Managers then create the portfolio’s positioning, assessing the available fundamental market opportunities and screening for the optimal risk-adjusted sector and security exposures. This process also defines exact duration and yield curve positioning within established ranges. Optimization models are used extensively.
3. Implement Allocations through Security Selection
The resulting strategy would be implemented through the US Government and mortgage-backed security specialists on the Global Rates and Securitized Products Team. Security selection is quantitatively-driven, with proprietary yield curve modeling used extensively. The Portfolio Managers continually assess prevailing relative value opportunities, mindful of the amount of risk they are able to “spend” in each. They consider the ideas in relation to existing positions and risk exposures, the risk budget and how it is currently filled, and market, trading, and liquidity considerations. The Strategy incorporates a variety of “fundamental value” trades while remaining within the constraints established by the portfolio's risk budget.
4. Daily Risk Monitoring
Each day, the Risk Management Team generates and analyzes reports on each area where active risk is taken relative to the portfolio’s risk budget. Portfolio managers and a separate Risk Manager receive risk reports for each portfolio on-line each morning. When a risk parameter exceeds a threshold limit, it is highlighted in the report. The Risk Manager discusses potential issues with the portfolio managers and, if needed, the Senior Risk Officer or Chief Investment Officer.
The risk reports for the proposed portfolio would highlight systematic risks, which we estimate via tracking error measures for yield curve and spread risks, as well as volatility and prepayment risks. Our risk reports also highlight fundamental value risks, which are risks due to "rich vs. cheap" security selection. We estimate fundamental value risks based on the long-term historical volatility and the current duration dollars at risk for each specific sub-strategy. We also estimate the volatility of each security’s "richness" or "cheapness" relative to the firm’s model prices over the past 20 days, providing an additional "short-term" fundamental value risk measure for the strategy.
1 There is no guarantee that these objectives will be met.
2 On average, over a full market cycle defined as three to five years.
No risk management technique can guarantee the mitigation of elimination of risk in any market environment.
Source: PGIM Fixed Income as of September 30, 2020.