Total/Book Return: The Good, The Bad & The Ugly...The Good. The Bad. The Ugly. Big Picture....

Total/Book Return: The Good, The Bad & The Ugly

Kevin Webb, [email protected]

Piper Jaffray

Rick [email protected]

President, FTN Main Street Advisors

Total/Book Return: The Good, The Bad & The UglyAgenda

Total/Book Return

The Good

The Bad

The Ugly

Big Picture


Big Picture – Philosophy, Strategy & Tactics

StrategyTactics

PhilosophyInvestment philsophy is a coherent way of thinking about the markets, risk, return, investor behaviour, etc.

A plan of action or policy to achieve one or more goals

(e.g., demonstrate good stewardship via a suitability

benchmark).

The intersection of philosophy, strategy & tactics is the world of

portfolio management

The Big Picture: Philosophy, Strategy & TacticsSleep-Adusted returns via Suitability Benchmark using evidence based methods.

Resources, skills & methods used to achieve the goal of a strategy (e.g., education, formulas, data, software, etc.)

The difference between strategy and tactics: Strategy is done above the shoulders, Tactics are done below the shoulders.

Designed and created by Kevin Webb, CFA

What Should I Benchmark?Prudent Person

Investments shall be made with judgment and care, under

circumstances then prevailing, which persons of prudence, discretion and

intelligence exercise in the management of their own affairs,

not for speculation, but for investment, considering the

probable safety of their capital as well as the probable income to be

derived.

Prudent InvestorA U.S. law that sets the standard of fiduciary duty for those entrusted

with the responsibility of managing others' money, such as trustees and

estate administrators. It requires that a trustee weigh risk versus reward

when making investment decisions, taking into account the income that

may be generated by the investment as well as the probable safety of the

invested capital.Prudent Investor vs Prudent Man/Person

1. Trust accounts are judged on their entire portfolio, rather than whether the investment was prudent at the time of purchase.

2. Diversification is explicitly required under the Prudent Investor Act3. Suitability is deemed more important than individual investments

4. Fiduciaries are allowed to delegate investment management to qualified third partieshttps://www.investopedia.com/terms/p/prudent-investor-rule.asp & https://www.investopedia.com/terms/p/prudentmanrule.asp

https://www.investopedia.com/terms/p/prudent-investor-rule.asp

https://www.investopedia.com/terms/p/prudentmanrule.asp

What Should I Benchmark?General Objectives

“The primary objectives, in priority order...1. Safety

Safety of principal is the foremost objective… The goal will be to mitigate credit risk and interest rate risk.

2. LiquidityThe investment portfolio shall remain sufficiently liquid to meet all

operating requirements that may be reasonably anticipated.3. Return

The investment portfolio shall be designed with the objective of attaining a market rate of return throughout budgetary and

economic cycles, taking into account the investment risk constraints of safety and liquidity needs.”

GFOA Sample Investment Policy, accessed 03/17/18, pages 1-2. Emphasis added.https://www.gfoa.org/sites/default/files/u2/SampleInvestmentPolicy.pdf

CFA Institute: Characteristics of Useful Performance Benchmarks

A benchmark is a collection of securities or risk factors and associated weights that represents thepersistent and prominent investment characteristics of a manager's investment process. Abenchmark should be:

• Unambiguous: The identities and weights of securities constituting the benchmark are clearly defined.

• Investable: It is possible to forgo active management and simply hold the benchmark.

• Measurable: The benchmark's return is readily calculable on a reasonably frequent basis.

• Appropriate: The benchmark is consistent with the manager's investment style and sectors.

• Specified in Advance: The benchmark is specified prior to the start of an evaluation period and known to all interested parties.

“The failure of a benchmark to possess these properties compromises its utility as an effective investment management tool. The properties listed merely formalize intuitive notions of what constitutes a fair and relevant performance comparison. It is interesting to observe that a

number of commonly used benchmarks fail to satisfy these properties.” CFA Institute

Seven Habits of Highly Effective Investment Programs by Rick Phillips, FTN Main Street Advisors, Kevin Webb, CFA, Piper Jaffray

http://www.gioa.us/presentations/2019/Thursday/Thu-Phillips_Webb_7_Habits.pdf

Benchmark Suitability

Designed and created by Kevin Webb, CFA

Benchmark Suitability

Designed and created by Rick Phillips (President, FTN Main Street Advisors)

Primary Liquidity 12%(Versus 0-3M Target 15%)

Secondary Liquidity 18%(Versus 3-12M Target 15%)

Total Liquidity 30%(Versus 0-12M Target 30%)

Effective Duration 2.1(Versus Target 2.00)

Moody's Composite Credit Rating Aa1(Versus Target Aa2)

Total Credit Exposure 30%(Versus Target 30%)

FYTD Book Rate Rate of Return 2.1(Versus Benchmark)

Book Yield 2.3(Versus Benchmark)

12 Month Total Rate Rate of Return 2.9(Versus Benchmark)

15%

15%

1.9%

2.5%

30%

30%

2.0

Aa2

1.7%

Brandreth, Gyles. Oxford Dictionary of Humorous Quotations (Kindle Location 4265). OUP Oxford. Kindle Edition. See this useful Microsoft Help page for Microsoft Word on the definition/history of “Lorem Ipsum Dolor Sit Amet Etiam”:

https://support.microsoft.com/en-us/kb/114222

Definitions

“Knowledge is knowing a tomato is a fruit; Wisdom is not putting it

in a fruit salad.”

https://support.microsoft.com/en-us/kb/114222

Risk DefinedMore things can happen than will happen.

Zweig, Jason. The Devil's Financial Dictionary (p. 182). PublicAffairs. Kindle Edition. Emphasis added.

… It has been philosophically defined by finance professor Elroy Dimson of London Business School this way: “Risk means more things can happen than will happen.” In the end, risk is the gap between

what investors think they know and what they end up learning— about

their investments, about the financial markets, and about

themselves.

*The scientist who developed the Saturn 5 rocket that launched the first Apollo mission to the moon put it this way: "You want a valve that doesn't

leak and you try everything possible to develop one. But the real world

provides you with a leaky valve. You have to determine how much leaking you can tolerate." (Obituary of Arthur

Rudolph, in The New York Times, January 3, 1996.)

Risk & Return are RelatedFinding the right trade-off is the key

Peter L. Bernstein. Against the Gods: The Remarkable Story of Risk (Kindle Locations 69-71). Kindle Edition. Emphasis added.


Total/Book Return – What’s the difference?


Why do we use Return instead of $?

The Theory and Practice of Investment Management (Frank J. Fabozzi Series) (Kindle Locations 1180-1189). Kindle Edition. Emphasis added.

“A rate of return is the gain received from an investment over a period of timeexpressed as a percentage. Returns are a ratio relating how much was gained given how much was risked. …

There are several reasons that returns have emerged as the preferred statistic for summarizing investment performance:

*The rate of return concentrates a lot of information into a single statistic. ...

*This single number, the return, is a ratio. It is faster for an investor to analyze proportions than absolute numbers. ...

*Returns are comparable even if the underlying figures are not. ...

*Returns calculated for different periods are comparable; that is, an investor can compare this year's return to last year’s. …

*The interpretation of the rate of return is intuitive. Return is the value reconciling the beginning investment value to the ending value over the time period we are measuring. … “

Total/Book Return Defined

PriceIncome


Income


Total Return: The Good, The Bad & The UglyAgenda


The Good – Risk Management Framework


3Mo CMT

2Yr CMT 5Yr CMT 30Yr CMT

3Mo CMT

2Yr CMT 5Yr CMT

30Yr CMT

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

0.0 5.0 10.0 15.0 20.0 25.0

Yiel

d To

Mat

urity

Yield Curve(s): 12/31/99 vs 08/31/1912/31/1999 8/31/2019

(600)(500)(400)(300)(200)(100)

03Mo 6Mo 1Yr 2Yr 3Yr 5Yr 7Yr 10Yr 30Yr

Yld Change

(100)

(50)

0

50

100

150

200

250

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

8.0

Dec

-99

Sep-

00

Jun-

01

Mar

-02

Dec

-02

Sep-

03

Jun-

04

Mar

-05

Dec

-05

Sep-

06

Jun-

07

Mar

-08

Dec

-08

Sep-

09

Jun-

10

Mar

-11

Dec

-11

Sep-

12

Jun-

13

Mar

-14

Dec

-14

Sep-

15

Jun-

16

2Yr CMT vs 3Mo CMT | Avg Spread: 46

Spread(bp) 3Mo CMT 2Yr CMT

Data from ICE, Bloomberg & FRED. Calculations, graphs & analysis by Kevin Webb, CFA.

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

Strategy Webb Yield Curve Perspective: Dec-99 to Aug-19

0.0 -1.0 1.0 -2.0 2.0 -3.0 3.0 -4.0 4.0 -5.0 5.0 -6.0 6.0 -7.0Data from ICE, Bloomberg & FRED. Calculations, graphs & analysis by Kevin Webb, CFA.

Main Street Ratio (Yield/Duration): 12/00 to 08/19

0.2

1.9

2.8

4.6

8.5

17.6

1.4 1.9 2.1

2.6 3.3

4.0

0.00

0.24 0.25 0.25

0.22

0.14

0.00

0.05

0.10

0.15

0.20

0.25

0.30

0.00

2.00

4.00

6.00

8.00

10.00

12.00

14.00

16.00

18.00

20.00

3-mo US TreasuryBill

US Treasury Current2 Yr

USTreasury Current3 Yr




Average Edur

Average Ytw

Main Street Ratio


Bellwether Treasury Average Duration (x-axis) vs Average Yield (y-axis): 12/31/00 - 08/31/19

3-mo US Treasury Bill [MSR #7]


US Treasury Current 2 Yr [MSR #3]

USTreasury Current 3 Yr [MSR #2]



US Treasury Current 30 Yr[MSR #6]

0.00

0.50

1.00

1.50

2.00

2.50

3.00

3.50

4.00

4.50

0.00 2.00 4.00 6.00 8.00 10.00 12.00 14.00 16.00 18.00 20.00

Bellwether Treasury Average Edur Average Ytw Main Street Ratio

3-mo US Treasury Bill 0.237 1.418 0.0006-mo US Treasury Bill 0.484 1.528 0.227

US Treasury Current 2 Yr 1.919 1.880 0.241USTreasury Current 3 Yr 2.807 2.119 0.250US Treasury Current 5 Yr 4.621 2.586 0.253

US Treasury Current 10 Yr 8.514 3.286 0.219US Treasury Current 30 Yr 17.578 3.964 0.145


Sharpe Ratio (Total Return): 12/00 to 08/19

0.5

1.6

2.4

4.2

7.3

13.9

1.5

2.6

3.3

4.2

4.9

7.0

0.00

0.70

0.73

0.62

0.45

0.39

0.00

0.10

0.20

0.30

0.40

0.50

0.60

0.70

0.80

0.00

2.00

4.00

6.00

8.00

10.00

12.00

14.00

16.00







Annualized Total Return StdDev

Annualized Total Return

Sharpe Ratio (Total Return)


Bellwether Treasury Annualized Standard Deviation (x-axis) vs Annualized Total Return (y-axis): 12/31/00 - 08/31/19

3-mo US Treasury Bill [SR #7]


US Treasury Current 2 Yr [SR #2]

USTreasury Current 3 Yr [SR #1]



US Treasury Current 30 Yr[SR #6]

0.00

1.00

2.00

3.00

4.00

5.00

6.00

7.00

8.00

0.00 2.00 4.00 6.00 8.00 10.00 12.00 14.00 16.00

Bellwether TreasuryAnnualized Total

Return StdDevAnnualized Total

ReturnSharpe Ratio

(Total Return)3-mo US Treasury Bill 0.500 1.542 0.0006-mo US Treasury Bill 0.571 1.822 0.491

US Treasury Current 2 Yr 1.574 2.642 0.699USTreasury Current 3 Yr 2.421 3.315 0.732US Treasury Current 5 Yr 4.218 4.166 0.622

US Treasury Current 10 Yr 7.309 4.859 0.454US Treasury Current 30 Yr 13.918 7.023 0.394


Duration vs StdDev Total Return: 12/00 to 08/19

0.2

1.9

2.8

4.6

8.5

17.6

0.5

1.6

2.4

4.2

7.3

13.9

0.00

0.70

0.73

0.62

0.45

0.39

0.00

0.10

0.20

0.30

0.40

0.50

0.60

0.70

0.80

0.00

2.00

4.00

6.00

8.00

10.00

12.00

14.00

16.00

18.00

20.00







Average Edur




Bellwether Treasury Avg Eff Duration (x-axis) vs Ann StdDev Total Return (y-axis): 12/31/00 - 08/31/19

3-mo US Treasury Bill6-mo US Treasury Bill

US Treasury Current 2 YrUSTreasury Current 3 Yr

US Treasury Current 5 Yr



0.00

2.00

4.00

6.00

8.00

10.00

12.00

14.00

16.00

0.00 2.00 4.00 6.00 8.00 10.00 12.00 14.00 16.00 18.00 20.00

Bellwether Treasury Average EdurAnnualized Total

Return StdDev3-mo US Treasury Bill 0.237 0.5006-mo US Treasury Bill 0.484 0.571

US Treasury Current 2 Yr 1.919 1.574USTreasury Current 3 Yr 2.807 2.421US Treasury Current 5 Yr 4.621 4.218

US Treasury Current 10 Yr 8.514 7.309US Treasury Current 30 Yr 17.578 13.918


Main Street Ratio (Yield/Duration): 12/00 to 08/19

2.5

2.4

1.5

2.8 2.8 2.7

2.1

2.3 2.2

3.2

3.5

3.7

0.25

0.36

0.55

0.64

0.73

0.82

0.00

0.10

0.20

0.30

0.40

0.50

0.60

0.70

0.80

0.90

0.00

0.50

1.00

1.50

2.00

2.50

3.00

3.50

4.00

US Treasuries 1-5yr Agy Bullet 1-5Yr Agy Callable 1-5Yr US Corp 1-5Yrs AAA-ABullet Ex Yanks

U.S Industrial Corp 1-5yr

US Financial Corp 1-5yr

Average Edur

Average Ytw

Main Street Ratio


Core Indices Average Duration (x-axis) vs Average Yield (y-axis): 12/31/00 - 08/31/19


US Treasuries 1-5yr [MSR #6]

Agy Bullet 1-5Yr [MSR #5]Agy Callable 1-5Yr [MSR #4]

US Corp 1-5Yrs AAA-A Bullet Ex Yanks [MSR #3]

U.S Industrial Corp 1-5yr [MSR #2]

US Financial Corp 1-5yr [MSR #1]

0.00

0.50

1.00

1.50

2.00

2.50

3.00

3.50

4.00

0.00 0.50 1.00 1.50 2.00 2.50 3.00

Fixed Income Sector Average Edur Average Ytw Main Street Ratio

3-mo US Treasury Bill 0.237 1.418 0.000US Treasuries 1-5yr 2.522 2.056 0.253

Agy Bullet 1-5Yr 2.356 2.258 0.356Agy Callable 1-5Yr 1.492 2.239 0.550

US Corp 1-5Yrs AAA-A Bullet Ex Yanks 2.750 3.178 0.640U.S Industrial Corp 1-5yr 2.799 3.463 0.730

US Financial Corp 1-5yr 2.735 3.665 0.822


Sharpe Ratio (Total Return): 12/00 to 08/19

2.0 2.0

1.1

3.1

2.8

3.8

3.1

3.4

2.5

4.2

4.6 4.4

0.76

0.93

0.86 0.87

1.10

0.76

0.00

0.20

0.40

0.60

0.80

1.00

1.20

0.00

0.50

1.00

1.50

2.00

2.50

3.00

3.50

4.00

4.50

5.00








Core Indices Annualized Standard Deviation (x-axis) vs Annualized Total Return (y-axis): 12/31/00 - 08/31/19


US Treasuries 1-5yr [SR #5]

Agy Bullet 1-5Yr [SR #2]

Agy Callable 1-5Yr [SR #4]

US Corp 1-5Yrs AAA-A Bullet Ex Yanks [SR #3]

U.S Industrial Corp 1-5yr [SR #1]

US Financial Corp 1-5yr [SR #6]

0.00

0.50

1.00

1.50

2.00

2.50

3.00

3.50

4.00

4.50

5.00

0.00 0.50 1.00 1.50 2.00 2.50 3.00 3.50 4.00 4.50

Fixed Income SectorAnnualized Total

Return StdDevAnnualized Total

ReturnSharpe Ratio

(Total Return)3-mo US Treasury Bill 0.500 1.542 0.000

US Treasuries 1-5yr 2.048 3.108 0.764Agy Bullet 1-5Yr 2.008 3.404 0.927

Agy Callable 1-5Yr 1.140 2.518 0.856US Corp 1-5Yrs AAA-A Bullet Ex Yanks 3.058 4.193 0.867

U.S Industrial Corp 1-5yr 2.765 4.571 1.095US Financial Corp 1-5yr 3.814 4.435 0.758


Duration vs StdDev Total Return: 12/00 to 08/19

2.5

2.4

1.5

2.8 2.8 2.7

2.0 2.0

1.1

3.1

2.8

3.8

0.76

0.93

0.86 0.87

1.10

0.76

0.00

0.20

0.40

0.60

0.80

1.00

1.20

0.00

0.50

1.00

1.50

2.00

2.50

3.00

3.50

4.00

4.50




Average Edur




Core Indices Effective Duration (x-axis) vs Ann StdDev Total Return (y-axis): 12/31/00 - 08/31/19

3-mo US Treasury Bill

US Treasuries 1-5yrAgy Bullet 1-5Yr

Agy Callable 1-5Yr

US Corp 1-5Yrs AAA-A Bullet Ex Yanks



0.00

0.50

1.00

1.50

2.00

2.50

3.00

3.50

4.00

4.50

0.00 0.50 1.00 1.50 2.00 2.50 3.00

Fixed Income Sector Average EdurAnnualized Total

Return StdDev3-mo US Treasury Bill 0.237 1.418

US Treasuries 1-5yr 2.522 2.056Agy Bullet 1-5Yr 2.356 2.258

Agy Callable 1-5Yr 1.492 2.239US Corp 1-5Yrs AAA-A Bullet Ex Yanks 2.750 3.178

U.S Industrial Corp 1-5yr 2.799 3.463US Financial Corp 1-5yr 2.735 3.665


3Mo6Mo

2Yr3Yr

5Yr10Yr

30Yr

Agg

Sp500Nasdaq

DJIA

MSCI

REIT

Cmdy

HFG

HFGew

HF-FF

Db-3Mo

(4.0)

(2.0)

0.0

2.0

4.0

6.0

8.0

10.0

12.0

0.0 5.0 10.0 15.0 20.0 25.0

Annu

aliz

ed T

otal

Ret

urn

Annualized Standard Deviation Total Return

Asset Class Risk/Reward Analysis: Sep-03 to Aug-19


Analysis Start Date: 9/30/2003 <-- 15.92 Yr(s) --> Analysis End Date: 8/31/2019

Asset Class/Market Sector

Risk-Adjusted ReturnAnnualized Standard

Deviation Total ReturnAnnualized Total Return Horizon Total Return

3Mo Tbill 2.811 0.486 1.366 24.1326Mo Tbill 2.973 0.543 1.615 29.062

2Yr Treasury BW 1.494 1.373 2.051 38.1843Yr Treasury BW 1.197 2.124 2.543 49.1745Yr Treasury BW 0.898 3.861 3.467 72.095

10Yr Treasury BW 0.630 6.938 4.368 97.57430Yr Treasury BW 0.492 13.963 6.873 188.279Bond Market Agg 1.280 3.362 4.302 95.616

S&P 500 0.679 13.579 9.223 307.683Nasdaq 0.663 16.474 10.926 421.554

Dow Jones Industrial 0.731 13.016 9.509 324.983MSCI World Equity 0.528 14.469 7.633 222.749

Dow Jones REIT 0.467 21.958 10.252 373.345Bloomberg Commodity (0.093) 16.112 (1.499) (21.382)

Hedge Fund Global 0.184 5.297 0.975 16.719Hedge Fund Equal Wgtd 0.884 5.714 5.052 119.264

Hedge Fund of Funds 0.644 4.904 3.159 64.109DB 3Mo Tbill Index 2.834 0.462 1.310 23.039





The Bad – Budgeting


Total Return DefinedTotal Return assumes indifference between Price return & Income return.

PriceIncome

Managing Investment Portfolios: A Dynamic Process (CFA Institute Investment Series) (p. 723). Wiley. Kindle Edition. Emphasis added.Mark P. Kritzman. The Portable Financial Analyst: What Practitioners Need to Know (Wiley Finance) (Kindle Locations 452-454). Kindle Edition.

“Total rate of return measures the increase in the investor’s wealth due to both investment income (for example, dividends and interest) and capital gains (both realized and unrealized). The total rate of return implies that a dollar of wealth is equally meaningful to the investor whether that wealth is generated by the secure income from a 90-day Treasury bill or by the unrealized appreciation in the price of a share of common stock.”

Price Income

What are your Return Preferences?Total Return assumes indifference between Price return & Income return.

PriceIncome

Managing Investment Portfolios: A Dynamic Process (CFA Institute Investment Series) (p. 723). Wiley. Kindle Edition. Emphasis added.

Total rate of return measures the increase in the investor’s wealth due to both investment income (for example, dividends and interest) and capital gains (both realized and unrealized). The total rate of return implies that a dollar of wealth is equally meaningful to the investor whether that wealth is generated by the secure income from a 90-day Treasury bill or by the unrealized appreciation in the price of a share of common stock.

IncomeMost public funds are income oriented and put more

weight on income. If you don’t budget gains/losses and aren’t tasked with portfolio growth from investments

then you likely have an income preference.

Income

Price

Total = Price + Cpn : 08/17 to 08/18

(2.6)(2.4)

(1.3)

(3.0)(3.2)

(3.0)

2.0

2.3

1.6

3.0

3.3 3.2

2.27 2.27 2.41

2.78

3.00 3.00

0.00

0.50

1.00

1.50

2.00

2.50

3.00

3.50

(4.00)

(3.00)

(2.00)

(1.00)

0.00

1.00

2.00

3.00

4.00




Annualized Price Return

Annualized Coupon Return

Average Ytw



3.3

2.2

1.8

3.2 3.2

3.4

2.3

2.8

2.1

3.2

3.6 3.6

2.32 2.37

2.54

2.85

3.15 3.18

0.00

0.50

1.00

1.50

2.00

2.50

3.00

3.50

0.00

0.50

1.00

1.50

2.00

2.50

3.00

3.50

4.00






Average Ytw



0.1

(0.0) (0.0)

(0.4) (0.4) (0.3)

3.1

3.4

2.5

4.4

4.7 4.6

2.06

2.26 2.24

3.18

3.46

3.67

0.00

0.50

1.00

1.50

2.00

2.50

3.00

3.50

4.00

(1.00)

0.00

1.00

2.00

3.00

4.00

5.00






Average Ytw


We are told that Total Return is “better” than yield.

Richard Cebula & Bill Yang, “Yield to Maturity is Always Received as Promised”, Journal of Economics and Finance Education Volume 7, no. 1 (2008): 43

“Yield to maturity (YTM hereafter) is “the standard measure of the total rate of return of the bond over its life. …… This interest rate is often viewed as a measure of the average rate of return that will be earned on a bond if it is bought now and held until maturity” (Bodie, et al, 2002, p. 426). And it is considered “the most accurate measure of interest rate” (Mishkin, 2004, p. 64). Unfortunately, due to a fact that “yield to maturity will equal the rate of return realized over the life of the bond if all coupons are reinvested at an interest rate equal to the bond’s yield to maturity (Bodie, et al, 2002, p. 429), YTM has been widely misinterpreted as “the true rate of return an investor would receive by holding the security until its maturity if each … interest payment is reinvested at the yield to maturity” (Strong, 2004, p.70, italic original). Similar interpretations can be also found in, to name a few, Reilly and Brown (1997, pp.530-531), Madura (1998, p. 217), and Fabozzi and Modigliani (2002, p. 364). “

i = Yield = IRR = Required Rate of Return = etc…

i = (FV/PV)^(1/n)-1YIELD TO MATURITY (YTM) concept used to determine the rate of return an investor will receive if a long-term, interest-bearing investment, such as a bond, is held to its MATURITY DATE. It takes into account purchase price, REDEMPTION value, time to maturity, COUPON yield, and the time between interest payments. Recognizing time value of money, it is the DISCOUNT RATE at which the PRESENT VALUE of all future payments would equal the present price of the bond, also known as INTERNAL RATE OF RETURN. It is implicitly assumed that coupons are reinvested at the YTM rate. YTM can be approximated using a bond value table (also called a bond yield table) or can be determined using a programmable calculator equipped for bond mathematics calculations. See also DURATION; HORIZON ANALYSIS; YIELD TO AVERAGE LIFE, YIELD TO CALL.

YIELD TO WORST bond yield assuming worst-case scenario, that is, earliest redemption possible under terms of the INDENTURE. See also YIELD TO CALL; YIELD TO MATURITY. (4)

INTEREST 1. cost of using money, expressed as a rate per period of time, usually one year, in which case it is called an annual rate of interest. (1)

REQUIRED RATE OF RETURN return required by investors before they will commit money to an investment at a given level of risk. Unless the expected return exceeds the required return, an investment is unacceptable. See also HURDLE RATE; INTERNAL RATE OF RETURN; MEAN RETURN. (2)

INTERNAL RATE OF RETURN (IRR) discount rate at which the present value of the future cash flows of an investment equal the cost of the investment. When the net present values of cash outflows (the cost of the investment) and cash inflows (returns on the investment) equal zero, the rate of discount being used is the IRR. When IRR is greater than the required return-called the hurdle rate in capital budgeting-the the investment is acceptable. (3)

1. John Downes;Jordan Elliot Goodman. Dictionary of Finance and Investment Terms (Barron's Financial Guides) (Kindle Locations 4807-4808). Kindle Edition. 2. John Downes;Jordan Elliot Goodman. Dictionary of Finance and Investment Terms (Barron's Financial Guides) (Kindle Locations 8221-8222). Kindle Edition. 3. John Downes;Jordan Elliot Goodman. Dictionary of Finance and Investment Terms (Barron's Financial Guides) (Kindle Locations 4849-4852). Kindle Edition. 4. John Downes;Jordan Elliot Goodman. Dictionary of Finance and Investment Terms (Barron's Financial Guides) (Kindle Locations 11433-11438). Kindle Edition.

https://www.wolframalpha.com/input/?i=solve%5BF%3DP*(1%2Br)%5En,r%5D

Strategy Webb Constant Maturity Treasury Yield, Duration & Convexity CalculationsPar Amount: $1,000,000.00 Treasury Yield Curve on 08/31/17

Treasury Maturity (Yrs): 5.00 Maturity Duration Yield Slope(bp) Slope(bp) to 3MoTreasury Settlement Date: 08/31/17 0.00 0.00 1.07%

Treasury Maturity Date: 08/31/22 0.25 0.25 1.01%Coupon Rate: 1.70% 0.50 0.50 1.08% 7.00 7.00

Yield: 1.70% 1.00 0.99 1.23% 15.00 22.00Price: 100.000 2.00 1.97 1.33% 10.00 32.00

Coupon Frequency: 2.000 3.00 2.93 1.44% 11.00 43.00Price (Excel): 100.000 5.00 4.77 1.70% 26.00 69.00Yield (Excel): 1.70% 10.00 8.97 2.12% 42.00 111.00

Modified Duration (Excel): 4.774 30.00 20.39 2.73% 61.00 172.00Table Calc Price: 100.000 100.042

Table Calc Yield (IRR): 1.700% 1.691%Table Calc Duration: 4.774 4.773

Table Calc Convexity: 0.2571 0.2570

Semi-Annual Periods Cash FlowPresent Value @

1.70% YieldMaturity Matched

Discount Rates

Present Value @ Maturity Matched

Rates0 (1,000,000.00) (1,000,000.00) 1.07% (1,000,000.00)1 8,500.00 8,428.36 1.08% 8,454.352 8,500.00 8,357.32 1.23% 8,396.413 8,500.00 8,286.88 1.28% 8,338.874 8,500.00 8,217.04 1.33% 8,277.615 8,500.00 8,147.78 1.39% 8,211.706 8,500.00 8,079.11 1.44% 8,141.887 8,500.00 8,011.02 1.51% 8,065.448 8,500.00 7,943.50 1.57% 7,984.579 8,500.00 7,876.55 1.64% 7,899.43

10 1,008,500.00 926,652.45 1.70% 926,652.45Total 1,085,000.00 1,000,000.00 1,000,422.70


Strategy Webb Toolkit: Paper Gains/(Losses) Vanish as Time PassesSettlement: 8/31/2019 Time Heals All Wounds

Maturity: 8/31/2024 Price Rates Rise Price Rates FallPar Amount: 1,000,000.00 0.00 95.31 104.95

Price: 100.000 6.00 95.76 104.46Coupon: 1.39% 12.00 96.21 103.97

Payment Frequency: 2 18.00 96.66 103.47Yield(Excel): 1.39% 24.00 97.12 102.98

Duration (Excel): 4.814 30.00 97.59 102.49Yield Move (+/-): 1.00% 36.00 98.06 101.99

42.00 98.54 101.4948.00 99.02 101.0054.00 99.51 100.5059.00 99.91 100.08

Assume rates rise or fall by the amount of the Yield Move (+/-) and see how time heals all wounds.

94

96

98

100

102

104

106

0 10 20 30 40 50 60 70

Pric

e

Months Gone by Since Purchase

Price Rates Rise Price Rates Fall


YTM is always received as promised

Richard Cebula & Bill Yang, “Yield to Maturity is Always Received as Promised”, Journal of Economics and Finance Education Volume 7, no. 1 (2008): 43

This note points out that the above-mentioned common treatment in many textbooks turns out to be a fallacy. The truth is that YTM on a (coupon) bond is always received regardless of how coupon payments are re-invested, provided that the bond is held until maturity without default. It addresses a basic question in bond theory: between YTM and realized compounding yield (RCY hereafter), which concept measures the true rate of return from holding a coupon bond until maturity? It is well accepted that YTM measures the rate of return from holding a bond until maturity for both coupon bond and zero-coupon bond as well. By definition, the YTM received from holding a bond is independent of how coupon payments are allocated, as long as they are paid on time as contracted. By comparing the initial investment and the final value accumulated over the investment horizon, on the other hand, RCY on a bond measures the rate of return from an account (or trust) that holds the bond and the interests paid. Of course, it depends on how coupon payments are reinvested. We demonstrate that the RCY actually measures the YTM from a combined investment - holding a coupon bond plus an additional periodic investment with each coupon payment received. Not surprisingly, YTM and RCY would be normally unequal; RCY equals YTM if and only if coupon payments are reinvested at the same rate as the initial YTM. However, this conclusion should not be interpreted as “the yield to maturity is actually received only if coupon payments are reinvested at the yield to maturity”.




The Bad – Budgeting

The Ugly – Portfolio Structure


Reporting Performance to Your Governing Body

PriceIncome


Income

We have sufficient liquidity, no need to sell anything, so new funds we

received will be working harder for us this next year at higher interest

rates!

Huh?Huh? Huh? Huh? Huh? Huh? Huh? Huh? Huh? Huh? Huh? Huh? Huh?

I have good news, we have an unrealized loss on the portfolio.


Don’t let Tactics drive PhilosophyDon’t let Wall Street make you over in their image and likeness…

Bruce Phelps, et. al. Quantitative Management of Bond Portfolios. Emphasis added.

...investors, who are predominantly concerned with book yield and risk adjusted book returns, can benefit from performance benchmarks that also use book accounting.

Because the book accounting performance of an index depends on the timing and amounts of cash inflows and outflows (and the particular rules for handling such cash flows) preceding the current performance month, no two investors will likely have the same book benchmark even if their underlying index is the same. By its very nature, a book benchmark must be customized for each investor to allow him or her to input their historical vector of cash inflows and outflows (including rules) so as to produce proper book accounting values in the current month. ...

The benchmark book yield and book income are indications of what could be achieved if the manager followed a passive strategy. ...

Don’t let Tactics drive PhilosophyDon’t let Wall Street make you over in their image and likeness…

Bruce Phelps, et. al. Quantitative Management of Bond Portfolios. Emphasis added.

Book Return vs Total Return



Graph Item Definitions

Annualized Total Return StdDev (Horizontal Axis)

Average Ytw (Vertical Axis)

This is the Average Yield To Worst and represents the

average over the period of all the yield to worsts. Yield to Worst is the lowest potential

yield that can be received without a default. Yield To

Worst over a given period can act as a proxy for what the

expected book income might have been. A higher number,

all things equal, is better.

The Standard Deviation of the Monthly Return

Annualized. Gives an indication of the historical

market value volatility. The higher the number the more volatile. A lower number, all things being equal, is better.

3-mo US Treasury Bill [#10|#10]

US Treasuries 1-3yr [#8|#8]

Agy Bullet 1-3Yr [#6|#3]

Agy Callable 1-3Yr [#1|#5]US Treasuries 3-5yr

[#9|#9]

Agy Bullet 3-5Yr [#7|#4]Agy Callable 3-5Yr [#3|#6]

U.S Industrial Corp 1-5yr [#2|#1]

US Financial Corp 1-5yr [#4|#7]

US Domestic Master [#5|#2]

0.00

0.50

1.00

1.50

2.00

2.50

3.00

3.50

4.00

0.00 0.50 1.00 1.50 2.00 2.50 3.00 3.50 4.00 4.50

Aver

age

Ytw

Annualized Total Return StdDevStrategy Webb Indices Comparison: 12/31/00 to 08/31/19

Fixed Income SectorAnnualized Total

Return StdDevAverage Ytw WEBB Ratio




3-mo US Treasury Bill 0.500 1.418 0.000 0.500 1.542 0.000US Treasuries 1-3yr 1.394 1.859 0.316 1.394 2.598 0.757

Agy Bullet 1-3Yr 1.527 2.082 0.435 1.527 2.974 0.937Agy Callable 1-3Yr 0.883 2.093 0.764 0.883 2.276 0.831

US Treasuries 3-5yr 3.340 2.389 0.291 3.340 3.990 0.733Agy Bullet 3-5Yr 3.234 2.657 0.383 3.234 4.474 0.906

Agy Callable 3-5Yr 1.742 2.529 0.638 1.742 2.965 0.817U.S Industrial Corp 1-5yr 2.765 3.463 0.739 2.765 4.571 1.095

US Financial Corp 1-5yr 3.814 3.665 0.589 3.814 4.435 0.758US Domestic Master 3.539 3.490 0.585 3.539 4.867 0.939


Problems with Indices/Total Return FrameworkRisk/Reward benchmarks should be based on your preferences!

Fixed-income benchmarks embody a great many complex issues … two

issues: the duration problem and the “bums” problem. …The

duration problem is the fact that the duration of the benchmark

comes from issuer preferences and is not necessarily the duration that a given investor should hold. The bums (or deadbeats) problem is

that the biggest debtors (whether companies, countries, or other

entities) have the largest weights in the benchmark.

Problems Using Bond Indices as BenchmarksBums & Duration

Investment Performance Measurement: Evaluating and Presenting Results (CFA Institute Investment Perspectives) (Kindle Locations 4006-4012). Wiley. Kindle Edition.

CDIAC Webinar “Understanding Benchmarking”, 2/28/19. Kevin Webb, CFA. CDIAC Webinar Link: https://www.treasurer.ca.gov/cdiac/seminars/2019/index.asp

https://www.treasurer.ca.gov/cdiac/seminars/2019/index.asp

The duration structure of a cap-weighted bond benchmark—that is, the proportions of bonds in short-, intermediate-, and long-term categories—reflects the maturity or duration preferences of issuers, who are seeking to minimize their (apparent) cost of capital. Investors, however, are not trying to minimize their

returns (which are the issuers’ costs of capital) but to maximize returns. Moreover, an investor usually has

specific time-horizon preferences that make one duration more advantageous than another. These preferences do not necessarily match those of issuers in the aggregate, whose preferences are reflected in the benchmark. ...

Because the benchmark duration is a historical accident, the optimal portfolio for an investor with no defined time

horizon should be set by that investor’s risk tolerance rather than by matching the duration of the benchmark.

The Duration Problem

Investment Performance Measurement: Evaluating and Presenting Results (CFA Institute Investment Perspectives) (Kindle Locations 4067-4082). Wiley. Kindle Edition. Emphasis added.



Because the issuers who manage to go deepest into debt—the biggest bums—have the largest weights in a

cap-weighted benchmark, such a benchmark is not likely to be mean-variance efficient. If you are tracking

such a benchmark, when someone issues a security, you have to buy it in proportion to its capitalization weight to

minimize tracking error to the benchmark, even if the security is only marginally of high enough quality to

make it into the benchmark and even if the size of the issue, and hence its weight in the benchmark, is

inordinately large. Such securities would seem to be the most likely to be downgraded or to default. The bums

problem applies to countries in an international sovereign bond benchmark just as it does to

corporations in a U.S. bond benchmark.

The “bums” Problem

Investment Performance Measurement: Evaluating and Presenting Results (CFA Institute Investment Perspectives) (Kindle Locations 4102-4107). Wiley. Kindle Edition. Emphasis added.



Kevin Webb, CFA Principal

Piper [email protected]

Contact Information

mailto:[email protected]

DisclaimerThe material contained herein is not a product of any research department of Piper Jaffray & Co. or any of its affiliates. Nothing herein constitutes a recommendation of any security or regarding any issuer; nor is it intended to provide information sufficient to make an investment decision. The information provided is herein not intended to be and should not be construed as a recommendation or "advice" within the meaning of Section 15B of the Securities Exchange Act of 1934.

The information contained in this communication has been compiled by Piper Jaffray & Co. from sources believed to be reliable, but no representation or warranty, express or implied, is made by Piper Jaffray & Co., its affiliates or any other person as to its accuracy, completeness or correctness. All opinions and estimates contained in this communication constitute Piper Jaffray & Co.'s judgment as of the date of this communication, are subject to change without notice and are provided in good faith but without legal responsibility. Past performance is not a guide to future performance, future returns are not guaranteed, and a loss of original capital may occur.

Total/Book Return: The Good, The Bad & The Ugly...The Good. The Bad. The Ugly. Big Picture....

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