Portfolio Risk Consequences of Fixed-Income Exposures

Interest rate and credit exposures can have quite different consequences for risk when viewed from a total portfolio perspective and from the perspective of a fixed-income portfolio in isolation. Within a fixed-income portfolio, interest rate exposure enhances volatility, whereas credit exposure can play a diversifying role. Conversely, at the total portfolio level, credit exposure tends to augment risk, While interest rate exposure may impact only modestly, or possibly even reduce, overall portfolio volatility. This dichotomy can give rise to agency problems when management of fixed-income portfolios is delegated. The author suggests various approaches for designing fixed-income mandates to better align them with investor objectives.