A Better Corporate Bond
Corporate bonds[i] are traditionally used to provide diversification and reduce risk in a portfolio while accepting a lower return. But, does this have to be the case? What if there was a solution that provided the diversification benefits of corporate bonds with higher expected returns and an even lower risk profile?
The effective yield[ii] corporate bonds provide can be broken down into two primary components: the risk-free rate[iii], and the credit spread. The risk-free rate, in this context, can be proxied by the 10-year Treasury rate.
Anything above the 10-year Treasury rate compensates the holder of a corporate bond portfolio for credit default potential, and is commonly known as the credit spread.
Although there are many things that affect the size of this spread, the primary driver is the market’s perception of corporate default risk, which increases during times of risk-off fear or during recessions.
When the corporate credit spread is overlaid with the CBOE Volatility Index (VIX) a correlation can be seen. This correlation is logical; when market volatility increases, for instance during a recession, the risk of default is also elevated.
Because of the relationship between volatility and the credit spread, Cassini is able to construct a portfolio that uses superior components that are closely correlated to corporate bond returns while reducing risk and increasing potential return.
To find out more about the positive correlation between the corporate credit spread and VIX, CLICK HERE.
The T+ Strategy
T+ replicates a corporate bond by combining 7-10 year U.S. Treasuries[iv] with limited risk volatility securities[v] (long VIX puts) to produce a return stream that is logically correlated with corporate bonds.
A hypothetical back test[vi] from January 1st 2007 to March 31st 2018 demonstrates the power of the T+ strategy.
Net Statistical Metrics
|Measure||Hypothetical T+||Corporate Bonds (LQD)|
|Annualized Net Returns||8.85%||5.15%|
|Max Peak-to-Trough Drawdown||6.69%||21.53%|
Historically the hypothetical T+ strategy provided greater downside protection, higher annual returns, and smaller drawdowns, with superior tax treatment relative to a corporate bond portfolio.
[i]Intermediate Corporate Bonds: are represented by an investment in iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD).
[ii]Corporate Bond Effective Yield: ICE Benchmark Administration Limited (IBA), ICE BofAML US Corporate 7-10 Year Effective Yield [BAMLC4A0C710YEY], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/BAMLC4A0C710YEY, June 20, 2018.
[iii]Risk-Free Rate: refers to rate that U.S. Government debt is paying for a similar maturity as the bond being considered.
[iv]U.S. Treasuries: Represented by an investment in iShares 7-10 Year Treasury Bond ETF (IEF) with reinvesting dividends.
[v]Volatility Securities: Represented by investments in Long VIX Index puts as determined by a proprietary algorithm. Cassini reserves the right to use other VIX futures traded products, such as but not limited to, The VelocityShares Daily Inverse VIX Medium-Term ETN (ZIV), or equity index option exchange traded products, such as but not limited to, WisdomTree CBOE S&P500 PutWriteStrat ETF (PUTW).
[vi]Hypothetical Back Test: The Strategy’s hypothetical returns are comprised of a back-test of a representative strategy from January 1st 2007 to March 31st 2018. The hypothetical returns are presented for informational purposes only and do not represent achieved historical performance. The algorithms used to produce the hypothetical returns are not necessarily the algorithms that will be used to manage the Strategy in the future. Cassini reserves the right to adjust the strategy as needed. The hypothetical returns are presented in US dollars and reflect the hypothetical reinvestment of all dividends and interest, accrued income, realized and unrealized gains or losses, and are net of hypothetical investment management fees and net of hypothetical fees after transactions. Hypothetical returns are not net of custodial fees if applicable. The applicable management fee schedule is 0.95% annually, deducted quarterly in arrears. Actual fees may vary based on, among other factors, account size and custodial relationship. Cassini Capital Management’s advisory fees are fully detailed in its Form ADV Part 2A. Full monthly return capsule is available upon request
Cassini Capital Management, LLC (CCM), is an investment adviser registered with the State of Florida; however, such registration does not imply a certain level of skill or training and no inference to the contrary should be made. Additional information regarding the Strategy, including investment management fees, as well as important information regarding CCM, its services, compensation, and conflicts of interest is contained in the firm’s Form ADV Part 2 and is available upon request or at www.adviserinfo.sec.gov. This presentation is not intended for the giving of investment advice to any single investor or group of investors and no investor should rely upon or make any investment decisions based solely upon its contents. The TPlus(T+) Strategy may not be suitable for all investors as the appropriateness of a particular investment or strategy will depend on an investor’s individual circumstances and objectives.
Limitations of Past Performance; Possibility of Losses: Past performance does not guarantee future performance. Participation in the Strategy carries the potential for profit as well as the probability of loss, especially over shorter time periods.
Other Fees and Expenses; Impact of Taxes: The investment management fee paid to CCM is separate and distinct from the internal fees and expenses charged by mutual funds and ETFs to their shareholders. These fees and expenses are described in each fund’s prospectus, and will generally include a management fee, internal investment, custodial, and other expenses, and a possible distribution fee. Prospective clients should consider all of these fees and charges when deciding whether to invest in the Strategy. Performance results for this strategy do not reflect the impact of taxes.
Comparative Benchmark Corporate Bonds (LQD) The iShares iBoxx $ Investment Grade Corporate Bond ETF seeks to track the investment results of the Markit iBoxx USD Liquid Investment Grade Index, composed of U.S. dollar-denominated, investment grade corporate bonds. Returns illustrated are net of fees.
Charts: All charts and graphs presented are property of Cassini Fund and were created for this presentation deck. Additional source material and statistical calculation details are available upon request.
Standard deviation A measure of the dispersion of a set of data from its mean. It is calculated as the square root of variance by determining the variation between each data point relative to the mean.
Sharpe ratio (mean portfolio return - risk-free rate)/standard deviation of portfolio return. With the risk-free rate equal to the average 13-week U.S. Treasury yield over time frame evaluated.