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ACTIVE RCIRTFOLI^ MANAGEMENT: STRATEGIES USED 8Y PRCIFESSfO1VAL INVESTMENT MANAGEF2S What exactly do fixed income portfolio managers do and how do they add value to a portfolio? In most instances, a client will choose a benchmark that represents the appropriate risk profile of their portfolio. The choice of this benchmark will depend upon the client's unique goals, risk constraints and cash flow considerations. Portfolio managers then guide the client's fixed income portfolio according to the chosen benchmark. Portfolio managers are evaluated by comparing their investment returns to the benchmark index. There are two important considerations here. First, how does the return of the portfolio compare to the return of the index? Secondly, and equally important, how does the volatility {risk) of the portfolio compare tothe index? There are several active management strategies which a fixed income portfolio manager may employ in order to maximize portfolio performance (and minimize portfolio risk). These include: RISK MANAGEMENT The first and most important job of a portfolio manager is to manage risk and protect the clients' principal. This is done by constant monitoring of any developments among individual securities held in the portfolio, as well as careful consideration of overall portfolio risk. Portfolio risk will vary depending upon the benchmark index that the client has chosen and can never be completely eliminated. Instead, the portfolio manager's task is to minimize risk relative to the chosen benchmark index. Over time, this will result in superior risk-adjusted returns for the portfolio, as well as increased peace of mind and a better night's sleepforthe client. MANAGING INTEREST RATE RISK Most academic and professional research indicates that interest rate forecasting is not a viable long-term investment strategy. {See the March 2006 Chandler Newsletter Article for more information on this subject). However, duration, which is a measure of a bond's sensitivity to interest rate changes, has been shown to be the greatest single determinant of portfolio performance. Therefore, astute portfolio managers manage interest rate risk by actively structuring their portfolios to match the risk profiles of their clients, as evidenced by the duration of the chosen benchmark index. STRUCTURING P^RTF^LI^S T^ TAKE ADVANTAGE ^F THE YIELD CURVE As the shape of the yield curve changes, a portfolio manager can outperform a market benchmark by holding different mixes of asset maturities. For instance, a portfolio consisting of equal parts of bonds maturing in one year and bonds maturing in 5 years may perform differently than a portfolio composed of 100% bonds maturing in 3 years, despite the fact that the average maturity of each portfolio is the same. An astute portfolio manager will take advantage of expected steepening or flattening of the yield curve by structuring the portfolio to hold the optimal mix of bond maturities. RELATIVE VALUE AM^NG DIFFERENT ASSET CLASSES AND SECTORS At various points in the economic and market cycle, Treasury, Corporate, Mortgage or Agency securities become relatively more or less attractive. These changes in relative value are often exacerbated by market sentiment or the actions of other market participants. At these times, a shrewd portfolio manager can alter the proportions of investments among these various sectors of the bond market. By doing so, the portfolio manager can generate additional returns without increasing market risk. SECURITY 5ELECTI^N Due to fluctuating market conditions, individual securities often become under or over valued. An astute portfolio manager that actively and continuously monitors the financial markets can identify these mispriced securities and buy or sell them. For example, if average single "A" rated corporates are trading at a spread of 75 basis points above treasuries, a portfolio manager may be able to identify a single "A" corporate issue that is yielding 80 or even 90 basis points above treasuries. If this security is issued by a company that has strong underlying fundamentals and a sound credit profile, there is an opportunityforthe portfolio manager to add value by purchasing the security. By doing this the manager may be able to increase portfolio return and decrease risk. Actively managing the elements of portfolio risk, concentrating particularly on matching portfolio duration to that of the appropriate benchmark, a portfolio manager can position their client for success. The portfolio manager with an active management strategy then utilizes portfolio structuring techniques, sector allocation, and individual security selection to further enhance investor returns in an effort to outperform the market benchmark without undue risk. Working with a professional portfolio manager that properly implements these techniques tan help a client to reach theirfinanciaf goals. Brian Perry is a Research Analyst at Chandler Asset Management Page 2 ®2006. Chandler Asset Management Inc, A Registered InvesimeniAdvisec