Core Plus is a portfolio management strategy that combines low-risk investment grade bonds with higher risk instruments to reduce costs, volatility, and taxes while maximizing returns. The core holdings track major market indexes, while the remaining 20-25% is allocated to actively managed short-term instruments. Credit rating is a key component, and managers must consider various risk factors when projecting the risk and return of an investment.
Core Plus refers to a portfolio management strategy that employs a combination of passively managed, relatively low risk, investment grade bonds with individually selected higher risk instruments. The rationale behind this strategy is to reduce costs, volatility and taxes while maximizing portfolio returns. In the Core Plus portfolio, the core holdings, comprising approximately 75-80% of the portfolio, track major market indexes, such as the Lehman Aggregate Bond Index or the Standard and Poor’s 500 Index. Investors in Core Plus funds hold these long-term investments, with the intention of offsetting the average return produced by the given instrument market. Investors allocate the remaining 20-25 percent of the portfolio to actively managed short-term instruments, with the opportunity for a skilled portfolio manager to outperform the market and improve returns.
The Core Plus portfolio’s primary holdings are traditional equity-based or fixed-income securities, such as passive mutual funds, index funds, or exchange-traded funds. Passively managed funds only trade assets when the underlying benchmarks change, which means fewer trades with lower loading fees and lower capital gains taxes. Administration fees are also low, compared to active management fees, because the manager only makes decisions when there are changes in the index. A core mutual fund maintains a mix of small to large cap funds that provide diversification across a variety of markets and jointly reflect a growth investing approach.
Periodically, market inefficiencies resulting from economic uncertainty provide opportunities for short-term investments in high-risk and undervalued securities, such as an investment property or a commodity option contract. The Core Plus portfolio can allocate up to 25 percent of its value to these types of investments. Projecting the risk and return of a given stock, bond or fund is a vital part of this process. Managers must take into account the various risk factors of any given investment, including credit ratings, interest rates, liquidity, leverage and currency risks. They also need to weigh the expense ratio relative to the yield, as the actual yield can be paltry when the expenses of an actively traded stock are subtracted.
Credit rating is a key component of resource allocation within a Core Plus portfolio. Securities tracked in the Lehman Aggregate Bond Index are primarily equity-based and funds using this index as a benchmark will be rated AAA, the higher credit rating. Junk bonds, while carrying higher yields, increase the fund’s volatility. Foreign currency exposure, encountered with foreign currency denominated bonds, also adds volatility and risk.
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