Frank J. Fabozzi, Lionel Martellini, and Philippe Priaulet,
Reviewed by Jon Ford, CFP®
Advanced Bond Portfolio Management is intended for anyone who wants to employ portfolio strategies that help control interest rate risk or enhance rates of return. It does an outstanding job of clarifying how to manage the risk and valuation associated with the forces that drive bond markets. It is not, unfortunately, written for most financial planners.
The editors assembled two dozen experts who describe topics in six broad areas. Part one provides an excellent background related to managing portfolios of fixed income investments, including the effects of liquidity on trading costs and strategies for creating and outperforming relevant benchmarks.
Part two expands the topic of benchmark selection by building liability-based benchmarks (such as those needed for meeting future obligations, like company pensions) and budgeting to accommodate risk to the portfolio. The importance of mean-variance optimization is demonstrated for creating the highest expected alpha for a given portfolio risk level.
Part three presents a summary of various modeling techniques and readers are encouraged to become familiar with the basic notions and assumptions made by the models. It is in part three that financial planners may begin to have difficulty with the concepts, as they are developed using integral calculus and partial derivatives; although fun to read and follow, the mathematical "demonstrations" do little to aid understanding for most general practitioners (and probably most investment advisors).
Managing interest rate risk for bond portfolios is the subject of part four. But again the usefulness of the chapters is limited by their dependence on mathematics that are not part of most financial planners' training. Matrix algebra and principal component analyses are said to allow bond portfolio mangers to go "beyond duration." I thought it was not so much that the reader was taken beyond duration but rather that the reader was introduced to probability variances that allow more flexibility in the use of duration as a bond portfolio is constructed.
Part five provides very well-thought-out fundamentals that are necessary to understand credit analysis and managing credit risk. There is more verbal explanation and less reliance on mathematical derivation in part five, which helped considerably in understanding the message. It was here that I began thinking that perhaps this book could actually have an immediate impact on our work with clients' portfolios.
Part six applied lessons introduced earlier in the book to the topic of investing in international bonds. It also expanded previous notions to include methods for building multicurrency and emerging market bond portfolios. It was emphasized that the volatility of these markets requires the use of an anchor such as a trusted valuation model, or else one risks being blown about by volatile political and economic events.
All in all, I found this to be an excellent set of chapters that would be very helpful to bond portfolio managers and upper level or graduate students in mathematical finance. It was not written for the vast majority of financial planner members of the Financial Planning Association; and although I found the book to be enjoyable (only because of training in mathematics and statistics), most readers would give up long before discovering the inherent continuity. I will not pick up this book again because I found little to help my clients move forward in their financial futures.
Jon Ford, CFP®, is president of CF Financial Planning Solutions Inc. in Cedar Falls, Iowa. He writes a weekly Financial Fundamentals column for the Cedar Falls Times.
$90 U.S., $116.99 Can. (hard cover: 558 pages)