The classic portable alpha model usually involves long and short investments in equities. But we’ve received several emails from concerned readers over the past few months about the lack of information out there for portable alpha enthusiasts in the fixed income department. Thankfully, help is on the way. Prudential Financial is now talking about “the burden of the long-only constraint” in fixed income portfolios.
In this report on “Pru Alpha” (actual product name), Prudential shows that prudent short selling of bonds can allow managers to bake more of their investment beliefs into a portfolio. Call it “fundamental law” meets fixed income. In fact, and with all due respect for the unique challenges of shorting on the fixed income desk, it’s as if Prudential had done a “search and replace” on the word “equity” on a traditional 130/30 marketing paper.
The following chart illustrates that, since most constituents in the Lehman Corporate Index comprise only a tiny portion of the index, the most a manager can express a negative view is to underweight that constituent a minute amount. Add the ability to hold a negative amount, and a manager can fully express their distain for certain positions.
Regular readers may recognize chart from papers discussing the similar concentration of equity indices. For example, this one from Merrill Lynch’s recent 130/30 paper:
Indeed, Prudential actually draws on the same academic rationale to justify its brand of fixed income 130/30. So while equity traders have always referred to fixed income managers as boring mathematicians and fixed income managers have accused equity desks of being a bunch of frat boys, it appears we can all agree on the merits of 130/30.