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.

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.

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.

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.

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.

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.