Yield-based benchmarks and Total Return Portfolio Experience

Yield-based benchmarks and Total Return Portfolio Experience

I get a lot of requests for advice.  Here are two of them.

Yield-based benchmarks and Total Return Portfolio Experience


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 I really appreciate you discussing your trading/haggling strategies in the Education of a Corporate Bond Manager.  It’s definitely given me new ideas and helped me get better pricing in my purchases the last couple of years.  I still refer to them every few months or so.

I have a question about changing jobs in the fixed income industry – I work in a treasury division, managing my company’s cash and short-term investments.  I’ve done well, but we use yield-based benchmarks, as part of the portfolio is used to immunize short term liabilities.  When I interview with asset management shops, they want previous total return portfolio management experience.    

Do you know any particular types of firms or sub-industries that use yield-based benchmarks?  Does managing to a yield benchmark stunt my learning growth compared to a total return mandate?


Yield-based benchmarks exist when:

  • The liability structure being invested against is short (We could need this cash at any moment for business use!)
  • The liability structure is long, but well-defined, such as a bank or insurer that wants predictable income versus their liabilities, and so the game becomes maximize spread net of default costs, subject to matching asset and liability durations (and maybe partial durations if the liability stream is long).

You are doing the first of these.  Truth, what you are doing could be measured on a total return basis, but it wouldn’t make a lot of difference.

The second one applies to banks and insurers, and can be done on either basis as well.  The difficulty comes with trying to calculate the total return of the liabilities.   If that it too hard to do, they create a bond benchmark that they think represents when they think the liabilities may pay out.  If the liabilities possess some degree of optionality, like that of residential mortgage prepayment, the benchmark could include bond options (long or short).

The yield on the bond benchmark is easy to calculate, as is the total return.   Thus relative performance can be calculated either way.  I had to do this for an insurance client once who insisted that our performance was poor when we had returned more than 0.70% year more than single-A corporate, which was quite good.

Thus, one place you could try working is for is an insurer, bank, or other financial intermediary.  But what of those that manage funds for retail.  What then?

Aside from unconstrained funds, even a mutual fund has a liability to invest against – the expectations of the client.  In that sense, most mutual fund managers aren’t doing full total return either – they have to stay within a certain range for interest rate sensitivity. They also could be evaluated on the basis of yield realized versus that of a generic portfolio meeting their interest rate sensitivity targets.  More commonly, they would be ranked against their competitors on a total return basis.

In closing, it you don’t want to manage money for a bank or insurer, you’ll have to try to wedge your way into work in a total return environment – taking a junior level position, and showing competence.  Believe me, most firms would love to promote from inside, if possible.



Dear Mr. David Merkel,

I really appreciate your hard work you are putting in your site and I am an avid reader of it. I would like to seek your advice regarding a decision I am facing. My goal is become a value investor and establish my own asset management firm to manage my own money and other people’s money. Right now, I have the opportunity to pursue partnership in my family business and be able to run it along with my father. I am 23 years old, and I am a freshman student at the _+_+_+_+_.  If I am to be a partner in my family business, I have to drop out from the university and travel to +_+_+_+_+_+_+_, where the business is. I am still a freshman student because when I was 19 years old, I dropped out to establish my own business in the same industry as my family in +_+_+_+_+_. I had an experience running a business and I had the opportunity to sell my business after two years of operation to my cousins, and, thankfully, it was a profitable venture.

My family business is somehow facing sales shrinkage and cash flow problem due to low capital (my family made terrible mistakes in managing it) and economic downturn. They are specialty contractors and manufacturers of fenestration products (windows, doors, kitchens, curtain walls, and rolling shutters). If I am to work with them, I can be able to help them in reorganizing the company. It might be risky for me, but if everything worked out well enough, I will have earnings that I believe is better than being an employee.

I am facing a decision that I need to make. You might not be able to advice me, but whatever advice you give me, I appreciate it. If my goal is to manage my own money and other people’s money by establishing my own asset management firm, is it helpful to have a university degree or the experience of having ran a business? Shall I drop out and pursue my family business opportunity? If I am to continue studying, I will incur student loan debt which I won’t prefer. But, alas, I will do it if it need be to accomplish my goal. Thank you a lot.

You have my sympathies on two fronts:

1) Choosing between family obligations and personal goals is never easy.  I have had to face that in deciding what jobs I could take while raising my family.  I was recruited for a managing director position in an investment bank in the mid-90s, but passed it up because I could not peel away that much time from my family and church.  It took a lot of time for me to become an institutional investor as a result.  I became an investment actuary at the age of 31, started working in an investment department at age 37, started work at a hedge fund at age 42, and started my own firm at age 49.  By 49, I had more than enough assets to care for my family if my business failed, at least to put the kids through college.   After that, I could be stretched.

2) Good operational businessmen can be very good investors.  There are synergies between the ability to operate a business, and the ability to make good investment decisions.  Don’t think that building another business is a waste of your time.  It will sharpen you in ways that most institutional investors never grasp.  I benefited a great deal from building profitable business within insurance companies, and it sharpened my knowledge on how to invest.

Now, all that said, if you take time out to rebuild your family’s business, don’t neglect your education.  Read good books on value investing, and study those who have been great.  I’m not saying that college is useless, but I am saying that much of the knowledge that academics teach on economics is deficient.  In some ways, it is better to be a clever businessman than an academically trained man.  The latter will not gain much insight into how to invest.  The businessman has a better chance.

Perhaps a good compromise would be to study for the CFA credential in your spare time.  I did that.  Along with that, invest some of your money in ideas that you think are worthy.  I did that from 1992-2003, before I began investing in stocks professionally, and I did very well.

You need to find out whether you have significant insights versus the rest of the markets.  Academic learning will not help that.  Operational business experience *might* help that.

Don’t give up your goal of managing your own value investing firm, but realize that there are many paths to getting there, and the most important thing is trying to develop insight into the markets that others don’t have.  Typically, academic study does not develop that.

I hope things work out for you.  Let me know how you do.



By David Merkel, CFA of Aleph Blog

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David J. Merkel, CFA, FSA — 2010-present, I am working on setting up my own equity asset management shop, tentatively called Aleph Investments. It is possible that I might do a joint venture with someone else if we can do more together than separately. From 2008-2010, I was the Chief Economist and Director of Research of Finacorp Securities. I did a many things for Finacorp, mainly research and analysis on a wide variety of fixed income and equity securities, and trading strategies. Until 2007, I was a senior investment analyst at Hovde Capital, responsible for analysis and valuation of investment opportunities for the FIP funds, particularly of companies in the insurance industry. I also managed the internal profit sharing and charitable endowment monies of the firm. From 2003-2007, I was a leading commentator at the investment website RealMoney.com. Back in 2003, after several years of correspondence, James Cramer invited me to write for the site, and I wrote for RealMoney on equity and bond portfolio management, macroeconomics, derivatives, quantitative strategies, insurance issues, corporate governance, etc. My specialty is looking at the interlinkages in the markets in order to understand individual markets better. I no longer contribute to RealMoney; I scaled it back because my work duties have gotten larger, and I began this blog to develop a distinct voice with a wider distribution. After three-plus year of operation, I believe I have achieved that. Prior to joining Hovde in 2003, I managed corporate bonds for Dwight Asset Management. In 1998, I joined the Mount Washington Investment Group as the Mortgage Bond and Asset Liability manager after working with Provident Mutual, AIG and Pacific Standard Life. My background as a life actuary has given me a different perspective on investing. How do you earn money without taking undue risk? How do you convey ideas about investing while showing a proper level of uncertainty on the likelihood of success? How do the various markets fit together, telling us us a broader story than any single piece? These are the themes that I will deal with in this blog. I hold bachelor’s and master’s degrees from Johns Hopkins University. In my spare time, I take care of our eight children with my wonderful wife Ruth.
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