Value of skill in security selection versus asset allocation in credit markets -: An "imperfect foresight" study.

The authors of this article simulate several styles of fixed-income portfolio management using a variation of the "perfect foresight" approach and explore performance at manager skill levels ranging h-om 0% (random selection) to 100% (perfect foresight). The portfolio strategies are designed so as to isolate the management styles: duration allocation, sector allocation, quality allocation, and security selection. Information ratios are reported for each strategy at various levels of manager skill. At equivalent levels of skill, the strategy based on security selection outperforms duration allocation and sector/quality allocation techniques in terms of information ratios. The number of independent decisions in the allocation process is a key determinant of strategy success. The advantage of security selection lies in the diversification of risk provided by making many security selection decisions simultaneously. This does not negate the importance of duration decision-making in fixed-income portfolio management.