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SGC's overall investment philosophy is predicated on the belief that a disciplined global approach focused on economic fundamentals and market conditions will produce superior long-term risk-adjusted returns. Although the basis of our approach is a quantitative and qualitative analysis of economic fundamentals, our approach cannot be accurately characterized without underscoring the operative terms "disciplined" and "global."
Our Fixed Income investment philosophy is not merely a slogan or abstraction. For us, this philosophy is the engine that has successfully driven our investment team to achieve the objective of outperforming client benchmarks over a full market cycle net of fees.
Our fixed income strategy defines our investment style, which has strong bottom-up elements with a top-down component.
Smith Graham’s Fixed Income investment philosophy has a relative value orientation with an emphasis on a bottom-up process. So, rather than having an economic view dictate the entire investment process, we believe that an independent examination should be made of each investment opportunity. Our objective is to look for investment opportunities where the expected returns are at least two times greater than the expected risk levels. Risk control is emphasized in our investment approach. Our analysis is undertaken in a structured framework where the risk dimension of our portfolios is explicitly modeled and managed. This approach enables us to better identify relative value opportunities in the fixed income market. The end result of our fixed income investment approach is high-quality portfolios with sources of return that are well diversified.
We focus on five key factors to add value to the fixed income portfolios that we manage. We believe that these five factors represent opportunities to enhance portfolio value while diversifying portfolio risk and reducing total return volatility.
The first and most important factor is Security Selection, which results from our emphasis on a bottom-up process. This factor is applied across all our investment strategies. Our investment team seeks to identify specific securities within a sector that are expected to provide superior performance. The framework for our analysis incorporates an evaluation of the expected sensitivity of each security’s underlying cash flows to anticipated changes in the yield curve environment including volatility. The calculation of risk-adjusted spreads and expected excess returns are additional elements of our framework. In selecting specific issues, we also analyze the structure of the security and its potential for rolling down the yield curve.
Sector Rotation and Yield Curve Positioning, are two other factors that are our major contributors to return. Sector and yield curve allocations are based on our reward to risk structured framework. We analyze historical data to determine changes in spread relationships, and we also utilize breakeven analysis to provide additional risk measures.
The fourth factor we utilize is Volatility Management. Here, we analyze the tradeoff between buying securities with superior yield versus superior price potential. Higher yielding securities outperform in a declining volatility environment, while securities with superior price potential outperform in a rising volatility environment.
Duration management is the fifth factor. While this factor is not a major emphasis for our style, we look for opportunities to add value by managing portfolio durations in a controlled and selective manner. We also ensure that our portfolio durations do not deviate by more than 10% to 15% relative to corresponding benchmark durations.
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