Fixed Income According Andy Carter

"If Andy Carter did not invent active fixed-income management, he is one of its very earliest practitioners," comments Peter Bernstein, someone well qualified to observe fixed-income history. And perhaps nothing epitomizes the development of investment management more than the changes in fixed-income practice in the last 30 years. Classic investment finance reserves the function of providing funds to run a business to equity. Borrowing, whether short-term or long-term, is matched to the payment flows of specific projects for interest and repayment of principal.

We have come a long way since this basic early understanding. Today, fixed-income instruments have rather little to do with specific projects but are another device, like equity, to raise permanent capital. As such, bonds are expected to be refinanced and bond quality is as much a measure of the likelihood of new investors to step forward to replace those who wish to move on to other investments as it is a measure of the profitability of business projects.

Bonds in the 1950s and 1960s were purchased by institutional investors for the major part of their portfolios and were normally held to maturity. These investors might have occasionally altered their quality preference, using rating agencies to attest to bond quality and covenants, but the modest changes they made were almost entirely through their selection of new issues. It was a slow, deliberate process. And expected bond returns were likely to be the coupon return to maturity and the repayment of principal. Many fixed-income portfolios were carried on an institution's accounts at par or purchase price, unadjusted for fluctuations in market value. After all, there was unlikely to be a sale before maturity so recognition of market fluctuations by changes in interest rates or creditworthiness was immaterial.

But then came the emergence of active fixed-income management. Sometime around the bull market excesses of the late 1960s and the collapse of equities in mid-1970s, the thought occurred to Andy Carter and a few others that bonds presented an opportunity for swaps. By studying the underlying characteristics of one bond, it might be possible to find a comparable instrument at a cheaper price. And with the knowledge that a trade could be done with someone who lacked this insight, perhaps a small but promising gain could be captured. Thus, the bond trading business and bond capital gain business were born.

Andy Carter looks like a flashy, dour Scot. Wearing a signature bow tie, he is totally immersed in the full range of fixed-income active management, having been there from day one. It tells us much about Carter that he followed his father as the top student at Loomis School and donated a residence hall there in his family's name.

Carter started in the investment business at Irving Trust in 1964. But his exploration into active fixed-income management began with the Harvard University endowment in the mid-1960s. Just as interest rates began a huge rise, the opportunity was available to show how a bond portfolio could be energized by trading compared with the historic strategy of buy-and-hold.

Carter took active bond management to a new firm, Thorndike, Doran, Paine & Lewis in Boston and then started his own operation in 1972. At both places, he collected a blue chip roster of institutional clients who expected, and received, a different style of bond management and paid equity-like fees for the service. He collected mandates of billions from demanding clients for management. Currently, he is chief executive officer of Hyperion, a bond management firm based in New York City.

Today, fixed-income management is the most quantitative of investment disciplines, incorporating the most extensive use of sophisticated derivatives and advanced statistical techniques of risk management (see Quantitative Investing and Risk Management). However, the well-publicized near demise of LTCM was active fixed-income management carried to its extreme. And Andy Carter can take the credit or blame for starting it all.