Portfolio Construction · Bonds Explained

Look through the security count

A portfolio can own dozens of bonds and still depend on one economic outcome. Several issues from a single banking group share important risks. Bonds from different companies in the same industry can also weaken together when financing or demand changes.

Map exposures by legal issuer, related group, sector, country, currency, seniority and maturity. For funds, use the underlying holdings rather than treating each fund as an independent asset.

Measure capital and sensitivity

Imagine a hypothetical $100,000 portfolio with $20,000 in each of five bonds. Equal position sizes look balanced. If three issuers depend heavily on the same energy price cycle, 60% of capital has a shared economic exposure.

Now suppose one $20,000 bond has duration 10 and another has duration 2. For a small parallel yield change, the first contributes roughly five times the rate sensitivity of the second, despite identical market values. Equal dollars do not imply equal risk.

Test correlations under stress

Relationships between assets can change during a crisis. Corporate credit and shares can weaken together. Government bonds may not offset an equity decline when the shock is driven by inflation and rising rates.

Diversification should therefore be assessed under several plausible conditions. Include a credit contraction, an inflation surprise, a currency move and a liquidity shock. Do not rely entirely on an average historical correlation.

Set understandable limits

A useful policy states how much can depend on one issuer group, which currencies are acceptable and how much liquidity is needed. The appropriate limits depend on objectives and capacity for loss.

Write down the reason for each holding. If several positions serve the same purpose and carry the same risks, adding another name may create complexity without much additional resilience. Review the combined exposures after purchases, maturities and fund changes.

Try it yourself

You own two funds that each allocate 30% to the same issuer group. Half your portfolio is in each fund. What is your combined exposure?

Show the worked answer

It is 0.5 × 30% plus 0.5 × 30%, or 30% of the total portfolio. Owning two funds does not halve that shared exposure.

Further reading

Educational material. Examples are hypothetical and do not recommend a security or a personal allocation. Contract terms and market conventions vary.

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