Hello guys, A quick question about the two strategies and their relation to immunization. From what I understand, bullet strategies offer better overall immunization due to their cash flows not being as dispersed in relation to the liability time horizon (as compared to a barbell strategy). I also understand that when constructing a barbell, the width of the assets needs to exceed the width of the liabilities (convexity and all that jazz). However the question I have is, when immunizing, why wouldn’t we always use a bullet strategy? Are bullet structures inherently less attractive in terms of total return? or are they more expensive to construct? or is the reason simply related to the portfolio manager’s preference and/or his views on the yield curve (shifts, twists, etc…). Thank you for helping me understand why not always bullet > barbell when immunizing.
What if bullet strategy is not possible on certain market with particular portfolio due to lack of issues for example?
Another reason, maybe is barbell more profitable and more adequate for some portfolios under various circumstances even by immunization process.
Barring the availability of bonds (the first point Flashback raised, which is valid) and assuming that’s not an issue/constraint. Would the only reason to deviate from Bullet immunization, towards Barbell immunization, be a portfolio manager’s view in regards to yield curve movements? I guess my question is - IF availability of bonds to construct either strategy is not an issue, and IF the portfolio manager had no view on yield curve movements, would a portfolio manager ever pick a barbell strategy over a bullet strategy when immunizing? if yes, why so? Is it based on the number of liabilities to be immunized? perhaps barbell is easier when there are many liabilities vs. bullet is easier with only a few liabilities? I can’t think of any other reasons, assuming this one is valid… haha
I think you nailed with the part where you ask about preference. Although I think it’s ultimately up to the client on how much discretion to give and whether they are allowed to deviate from matching large and or small risk factors. Availability of certain bonds may factor in but I think that’s more of an issue for cash flow matching. I remember reading in curriculum about 3 criteria to immunize a multi liability portfolio but I don’t have book on me so correct me if this wrong please. Must match total duration, key rate duration and bond durations must be dispersed wider than the liability durations. I think I messed one of those up though …
I did mess that up…
"Multiple Liabilities
The key to immunizing multiple liabilities is to decompose the portfolio payment streams in such a way that the component streams separately immunize each of the multiple liabilities. Multiple-liability immunization is possible if the following three conditions are satisfied (assuming parallel rate shifts):
Assets and liabilities have the same present values.
Assets and liabilities have the same aggregate durations.
The range of the distribution of durations of individual assets in the portfolio exceeds the distribution of liabilities. This is a necessary condition in order to be able to use cash flows generated from our assets (which will include principal payments from maturing bonds) to sufficiently meet each of our cash outflow needs."