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Dedicated Portfolio

Reviewed by Sujaini | Updated on Sep 30, 2020

Catalogue

What is a Dedicated Portfolio?

A dedicated portfolio is an investment portfolio, where cash flows balance the planned liabilities. Dedicated portfolios are typically operated passively and consist of stable fixed-income assets of investment-grade quality. Financial analyst, Martin L. Leibowitz, who wrote extensively on the concept, has advocated dedicated portfolios calling it a cash-matching technique.

Bonds and other fixed-income securities are bought in a dedicated portfolio and typically retained until maturity. The aim is to create a cash flow from the coupons matching payments that must be made over a specified period.

Dedicated funds use securities of an investment-grade to mitigate default risk. However, returns may be constrained by the quality and stability of investment-grade securities.

Advantages of a Dedicated Portfolio

Dedicated portfolios are ideally fit for investors seeking a stable source of potential profits. These will have steady cash flow while mitigating market risk, risk of reinvestment, risk of inflation, risk of default, and risk of liquidity.

Drawbacks of a Dedicated Portfolio

It can be mathematically challenging to evaluate the least expensive portfolio with the corresponding length and coupon. Creating dedicated portfolios includes experience in fixed income, high-level mathematics, and knowledge and understanding of liabilities in the theory of optimisation. Additionally, other types of bonds are not appropriate for dedicated portfolios.

Example of a Dedicated Portfolio

Assume a corporation has a pension plan, and expect payments to start in 20 years. The company was able to calculate the estimated liabilities, and then create a fund that would produce the correct amount of cash to cover the liabilities with little investment risk based on the overall value plus interest payments.

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