Risk
Management
We believe that diversification is key to appropriate corporate bond
investment. No matter how good the credit analysis or the underlying
situation of the issuer, there is the potential for disruption to cash
flows that cannot be foreseen. Such a disruption can be disastrous for
a weaker or lower quality credit.
Our firm defines risk in terms of absolute capital loss. In our bond
portfolios, we use a proprietary system of default risk for our bond
holdings called Maximum Loss. This system limits each position according
to its potential impact on a portfolio's long term value-added. Each
position is analyzed independently. The higher the trading price of
a security compared to its downside potential, the smaller the position
allowed. The risk assessment allows the security's specific features
that modify its downside risk to be considered. This includes the priority
of the security and nature of the issuer.
Our security selection is not independent of our risk management. Since
some of our portfolios allow us to hold AAA to defaulted securities,
we frequently trade in distressed names and are very familiar with the
bankruptcy and reorganization process. This helps recognize the capital
risk inherent in many popular issuers that have considerable downside
risk despite their published ratings. Portfolio weightings in credit
cohorts are established by client agreed constraints reflecting client
risk tolerances.
Portfolios are diversified by issuer type and industry sector. Positions
are then limited individually by the determination of the Maximum Loss
potential of each issue.
Compared to commercial credit ratings, Maximum Loss compares
the loss potential of a security to its trading value. This limits exposure
to bonds trading expensively compared to their potential losses and
encourages purchase of bonds trading near or below their workout values.
This limits the portfolio's downside risk and creates more upside potential
than by using traditional credit rating methodology.