If they will not perform the same, how would you go about determining which would perform best assuming that you have a six-month investment horizon?
What will be an ideal response?
To determine which portfolio would have the superior performance, we would want to look at the total return for the six-month investment horizon given expectations about change in yields and how the yield curve will shift. More details are given below.
It is important to note that measures such as yield (yield to maturity or some type of portfolio yield measure), duration, or convexity tell us little about performance over some investment horizon, because performance depends on the magnitude of the change in yields and how the yield curve shifts. Therefore, when a manager wants to position a portfolio based on expectations as to how he might expect the yield curve to shift, it is imperative to perform total return analysis. For example, in a steepening yield curve environment, it is often stated that a bullet portfolio with the same duration as a barbell portfolio would perform better that the barbell portfolio. However, as can be seen from Exhibit 24-5, it is not the case that a bullet portfolio would outperform a barbell portfolio. Whether the bullet portfolio outperforms the barbell depends on how much the yield curve steepens. An analysis similar to that in Exhibit 24-5 based on total return for different degrees of steepening of the yield curve clearly demonstrates to
a manager whether a particular yield curve strategy will be superior to another. The same analysis can be performed to assess the potential outcome of a ladder strategy.
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