Dedicated Portfolio

What Is a Dedicated Portfolio?

A dedicated portfolio is an investment portfolio where the cash flows are designed to match the anticipated liabilities. Dedicated portfolios are usually passively managed and are composed of stable, investment-grade fixed-income assets.

Understanding Dedicated Portfolio

Dedicated portfolios were promoted by financial researcher Martin L. Leibowitz, who wrote extensively about the idea, calling it a cash-matching strategy. In a dedicated portfolio, bonds and other fixed-income instruments are bought and usually held until maturity. The goal is to create a cash flow from the coupons that match payments that need to be made over a set time.

Dedicated portfolios use investment-grade securities to minimize the risk of default. The security and stability of investment-grade securities can limit returns, however.

Advantages of a Dedicated Portfolio

Dedicated portfolios are most appropriate for investors who need a reliable source of income for the future. They can provide predictable cash flow while reducing market risk, reinvestment risk, inflation risk, default risk, and liquidity risk.

Drawbacks of a Dedicated Portfolio

Determining the least expensive portfolio with a matching duration and coupon can be mathematically challenging. Constructing dedicated portfolios requires fixed-income expertise, high-level math, and optimization-theory knowledge and understanding of liabilities. Also, many forms of bonds are not appropriate for dedicated portfolios.

Example of a Dedicated Portfolio

Assume a company has a pension fund, and that it expects to make payments beginning in 20 years. The company could determine the expected liabilities, then build a portfolio that — based on the overall value plus interest payments — would generate the correct amount of cash to pay the liabilities with little investment risk.

Liability-Driven Investing — LDI

A popular application of a dedicated portfolio in retirement investing is called liability-driven investing. These plans use a "glide path" that aims to reduce risks — such as interest rate or market risks — over time and to achieve returns that either match or exceed the growth of anticipated pension plan liabilities.

Liability-driven investing strategies differ from a “benchmark-driven” strategy, which is based on achieving better returns than an external index such as the S&P 500 or a set of benchmarks representing various investment asset classes. Liability-driven investing is appropriate for situations where future liabilities can be predicted with some degree of accuracy. For individuals, the classic example would be the stream of withdrawals from a retirement portfolio over time beginning at retirement age. For companies, the classic example would be a pension fund that must make future payouts to pensioners over their expected lifetimes.