Fixed income Risk and Return 451 the manager must now effectively run each of the strategies to achieve the estimated added value.

investment funds

Another important factor is that you will note that these risk allocations are done at the strategy level, not the actual risk exposure level. The risk allocations and correlations are averages rather than spot estimates. Therefore, it is important to understand the expected risk at each point in time based on the actual exposures that are in the portfolio. It may be the case that although you have estimated that two strategies are uncorrelated on average, the specific trades that have resulted from the strategies at a given point in time are expected to be highly correlated. In this instance, the manager should be aware of the potential increase in tracking error and actively decide whether it is appropriate to exhibit more than average risk at that time or to dial back one or both of the exposures. Also, as time goes by, the manager may change his or her estimates on the information ratio of the strategies, the correlations between the strategies, or the maximum amount of risk that can be taken based on new performance information, increases or decreases in resources dedicated to each strategy, a change in market volatility, or a belief that the future opportunities to add value in a particular strategy have gone either up or down relative to prior expectations. Hopefully, we have given the reader a sense of the issues to consider when investing in the rather complex fixed income markets.

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