What are the implications of findings regardingvarious types of constraint-tolerating investingfor setting an investment policy for corporatebond portfolios?

Question

What will be an ideal response?

Answer 1

The major study providing implications is by Ng and Phelps. Their findings gives guidance as to whether portfolio managers should be tolerant of any violation in the inclusion requirements and continue to hold an issue that has been removed from the index. They look at the credit spread premium (i.e., the return in excess of a Treasury portfolio with similar duration) of a portfolio that permits an issue removed from the index to be retained and compares that to the index itself. Specifically, Ng and Phelps construct different "tolerant" portfolios, which they refer to as "alternative corporate indices." The five tolerant portfolios that has implications for setting an investment policy for corporate bond portfolios are as follows:

1, Downgrade tolerant: Downgraded bonds are retained in the portfolio as long as they meet the maturity and liquidity requirements.
2, Remaining maturity tolerant: Permits the holding of issues with a maturity of one year or less but not if they are downgraded to noninvestment grade or if they fall below the liquidity requirement.
3, Liquidity constraint tolerant: Permits the holding of an issue if it falls below the minimum liquidity requirement ($250 million) but not if it is downgraded to noninvestment grade or has a maturity of less than one year.
4, Investment-grade only full tolerant: Any issue that is investment grade may be included even if it violates the maturity and liquidity requirement. That is, downgraded issues to noninvestment grade are not permitted.

In conclusion, the Ng and Phelps study provides preliminary evidence for bond portfolio managers to hold issues that have been removed from the Barclays Capital Investment Grade Corporate Index. The implications are that managers should consider a variety of "tolerant" strategies.