Bitcoin Volatility: Evidence of Market Maturity After Cryptocurrency Craze

Since the inception of Bitcoin and the concept of ‘digital assets’, institutional and retail investors kept their distance (and rightfully so) given the extreme volatility in prices, uncertainty around regulation, and questions around consumer adoption. Not only was the concept of Bitcoin foreign, but potential opportunities surrounding the digital currency and its underlying technology were also quite nascent.

As investors and entrepreneurs increased attention and resources to trading, mining, and building tangential services around these digital currencies, we have witnessed a bumpy road to stabilization and maturity. A study of market cycles demonstrates the relative boom and bust of any new industry. A particular article in Hackernoon shows a great example of this by overlaying BTC prices on stock market performance during the inflating and pop of the dotcom bubble.

In order to attract capital and accelerate a new growth cycle, trading statistics of cryptocurrencies need to be more in line with traditional asset classes. Evidence of that trend has already been reflected in trading price data. Analyzing the trading data of the top cryptocurrencies (based on market capitalization), a decline in 30-day rolling volatilities and significant compression in the volatility spread between BTC with the S&P 500 and Russell 3000 indices were observed.

While there is certainly a long way to go until the industry begins to “mature” (with respect to long term cycles), the sharp decrease in implied volatilities points to certain tailwinds.

First, there have been a plethora of services and applications built with blockchain tech and successful companies in the space are now emerging. Payment services companies such as BitPay demonstrate various applications focused on consumer and business adoption. Ripple’s partnerships provides further evidence that there are tangible results that will disrupt status quo tech. The Zerocoin project has improved its capabilities and made meaningful progress towards secure transactions.

Second, investors are starting to reap rewards of their early investments in blockchain and recycle capital within the industry. The success of Coinbaseillustrates blockchain companies can attract significant investor attention and capital. Prior management teams that have exited these companies have been able to raise money for their own projects; their niches are focused on plugging gaps with current technology offerings.

Finally, large multi-national corporations are beginning to introduce new and specialized product lines for industry participants. For example, Samsung released a new chip to improve BTC mining profits. These new products will reduce the overall marginal cost to enter related markets, just as cloud computing decreased the capability gap between small and large corporations.

While we cannot ascertain where the winners will be (equity investors, miners, coin investors, etc.), there seems to be a long runway for investors and entrepreneurs to figure it out. What we can see is that the railroad is making its way to the wild west, both the numbers and trends point to opportunities for those paying attention.


4 Takeaways from SEC Registration Charge Settlements with Airfox and Paragon

First Takeaway: The SEC Means Business and is Polishing their Playbook

First, the recent settlement of SEC Registration charges against Paragon and Airfox on November 16, 2018 is likely the first of many civil penalties levied against cryptocurrency businesses. The ruling also represents an important legal precedent where the SEC applied guidance from the 2017 DAO Report of Investigation (Release №81027 / July 25, 2017). The guidance was used to charge both Airfox and Paragon for violating Section 5(a) and 5(c) of the Securities Act by “offering and selling these securities without having a registration statement filed or in effect with the Commission or qualifying exemption from registration with the Commission.” PRG and Airtokens were represented as “Utility Tokens” to present themselves fundamentally as glorified Kickstarter projects rather than securities.

The DAO Report set a framework to predict how the SEC would interpret securities law when applying them to ICOs despite labels as a security or utility token. Below are a few of the foundational principles of securities law from the DAO Report applied to capital raising via cryptocurrency offerings.

1) Determination of whether an investment contract exists. A key item distinguished was that the investment of “money” does not necessarily need to take the form of fiat currency. Using ETH to make investments was specifically cited (such as exchanges involving smart contracts). Tokens that fit the Howey test are determined to be securities.

2) Reasonable expectation of profits. Despite the focus on funding development projects, the tokens were presented and structured in a manner where a reasonable investor would have been motivated by the “prospect of profits on their investment.”

3) Benefit derived from the managerial efforts of others. The responsibility for shepherding the raised capital and generation of profit was assumed to be tied to the efforts of the management team. This increases in importance when considering management teams using cryptocurrencies to compensate employees and contractors.

4) Voting rights are a critical distinguishing factor. Based on the structure of these companies, there are a number of limiting items for the overall control of token holders. In addition, given that token holders are often widely dispersed and lack the ability to communicate with one another, there is an even greater burden placed on management to prove their efforts are not being relied upon for economic gain.

5) Information rights are important. Whether it is an unplanned hard fork or change in monetization strategy, it is important for token holders to have a reasonable amount of information to make an informed decision. This is likely to increase the burden on management teams to effectively communicate their results and general business plans in a more structured manner.

Second Takeaway: No Fraud Charges Levied

The SEC charged the two companies with a $250,000 fine and a cease-and-desist order until they can be properly registered. Notably, no criminal charges were applied in either case. This demonstrates that the SEC is focused on establishing registration requirements and enforcement mechanisms to create a more predictable ICO market. While these rulings may not establish a clear bright line on a number of other securities items pertaining to cryptocurrency markets, the blue prints for ICO compliance seem to be coming together.

Third Takeaway: Labeling it as a “Utility Token” Means Nothing

None of the defenses based on the label of a “utility token” were strong enough to avoid the categorization of each token as a security. A utility token is issued in order to fund development of a cryptocurrency and future marketplace where the token would be exchanged for a particular good or service. The legal defense of a utility token to avoid the label of a security is tantamount to comparing themselves to Kickstarter projects. However, the SEC determined that the promise and hope of asset inflation creates a fundamental point of distinction.

Fourth Takeaway: Investor Relations is Important

The SEC consistently discussed the promotional efforts on social media, email communications, blockchain communities / chat sites, and white papers in applying securities law. Similar to virtually every other asset class, the overall communication of the opportunity was evaluated in a legal vacuum to determine whether the tokens were securities and if they were exempt from registration.


While there are likely much more settlements in the SEC pipeline, we are starting to see the development of clear standards for ICO markets. This positive trend will culminate in more clear standards for asset monetization strategies using blockchain technology. Future guidance on the following topics are likely over the next few years:

· Equity compensation rules around distribution of cryptocurrency

· Trading rules surrounding secondary markets

· Liquidity requirements (for instance, escrow accounts held in ETH)

· Information rights

· Voting rights

· Governance structure

· Distributed ledger technology security

· Industry-specific applications (i.e., gambling, gaming, cannabis, etc.)

Public Blockchain Companies: Understanding Risk for a New Market

Without the advantage of being part of a reputable VC or Angel group, or actively working on early-stage company investments, public market information offers retail investors with the best knowledge to invest in micro and small cap companies. Due to the asymmetric information and profit potential associated with any new industry, there will always be winners, losers, and fraud. Penny stock trading hacks show that this fraud can be depicted in the form of newsletters, sexy new ‘ICO deals’, fake advisors, and fake thought leaders.

In order to understand this risk, investors typically analyze the trading history of publicly traded stocks and form ratios (e.g., beta, volatility, etc.) to compare. Analysts can then split risk into various categories based on size, geography, industry, and so forth. These ratios are often compared against benchmarks such as the S&P 500 and the Russell 2000 to gauge relative risk of each position. Also, in theory, high risk of a particular stock can be ‘diversified’ through the addition of uncorrelated stocks in the context of a portfolio.

Unfortunately, investors in cryptocurrency assets and companies lack a strong public market to assess these industry and operating risk factors that have been traditionally embedded in the trading prices of public stocks. Since the volatile end of 2017 to the beginning of 2018, investors rushed into the asset class to share in the promises of finding the Treasure of Lima. Comments like “Ethereum and Bitcoin seem to be safe given the attraction of institutional money” or “I’m going to take a shotgun approach and see what sticks” built a guise of both stable and rapid growth, both of which have not played out over the last year.

Rather than focus on the drivers of the market, the intent of this post is to analyze publicly traded companies to better understand risk. We analyzed 29 publicly traded blockchain-focused early-stage companies (Exhibit A) that were primarily pre-revenue in the blockchain industry; the companies trade across various international exchanges such as the TSXV, Nasdaq, and CNSX and on the pink sheets. We then calculated a market capitalization weighted index and observed the Crypto Currencies Index[1] to compare traditional ratios against these two benchmarks. It’s important to remember that these two indices represent different estimates of performance. The average market cap method measures the performance of the 29 selected companies. The CCI 30 index represents performance of cryptocurrency assets. While we would assume the indices to be highly correlated during sharp up and down movements, one area of focus was to see whether there was a decoupling effect between the two asset classes (like the relationship between gold and gold-mining companies) in performance after the recent drawdown of cryptocurrency asset values.

The first chart shows the risk-to-reward ratios (based on calculated weekly performance and volatility since the beginning of 2014) of the 29 companies and the indices. The indices also show greater risk-to-reward ratios, indicating potential benefits of diversification. A majority of the positions illustrate a weekly volatility range of 10 to 30 percent. This implies annual industry volatility of approximately 70% to 200%.

Chart 1 — Plot of Publicly Traded Companies

The second chart illustrates the growth of the market cap weighted index and CCI 30 index compared to the total IPO values (calculated as the market cap on the first trading week) over time. The area chart represents the gross invested capital of each position but ignores and fluctuations in the underlying stock. The indices (represented by the line charts) demonstrate the strong performance of cryptocurrency assets through the beginning of 2018, followed by a sharp fall.

The analysis reveals a few items. First, the trend of asset inflation likely contributed a almost $800 million of new IPO money flowing after the new year. Second, we calculated volatility ratios since the beginning of 2014 (or since inception of the other companies). Calculated off weekly performance, the implied volatility figures were significantly greater than those calculated for general market indices such as the S&P 500 (Exhibit B, at the time of this post the VIX index was trading around 19). In addition, we observed differences in risk associated with business strategy. For example, Hut 8 Mining Corp. represents a relatively recurring revenue type business model. On the other hand, Blockchain Technologies, Inc. is an early stage R&D company focused on applications to IoT. As the industry matures, we expect additional differences and sub-industries to emerge. However, for the most part, it seemed that the two asset classes were fairly correlated over the last 1–2 years.

Chart 2 — New Blockchain Companies

Finally, we wanted to note the obvious shortcomings with the analysis, which include (i) the short trading histories above the different companies, (ii) we ignore invested capital from large strategic companies such as IBM or Oracle, (iii) the private capital markets are substantially larger, and (iv) the initial focus for retail investors has been the currency rather than the underlying equity. Over time, we expect new innovations and industry maturity to allow valuation professionals and investors to increase reliance on traditional valuation tools.


[1] CCI30, Source:, Represents a barometer of cryptocurrency asset performance by analyzing the top 30 market cap cryptocurrency assets (index methodology is located on their website).

Questions to Ask Before Blockchain Implementation — An Interview with MIMIR Blockchain Solutions

Today, I sat down with Forrest Marshall (Software Architect) and Mustafa Inamullah (Creative Director) of MIMIR Blockchain Solutions to discuss the current state of blockchain technology and their company. The intent of the interview was to uncover some of the key value drivers of the blockchain industry and separate fact from fiction after the recent popping of the cryptocurrency bubble.

For a quick summary of MIMIR Blockchain Solutions, please view the video located at the end of this blog post.

Thanks again for sitting down with us today. Given recent market dynamics (you end last paragraph with same phrase), we wanted to begin today by discussing some of the lessons from the Dot Com bubble and how they apply to blockchain. Could you discuss some of the learned themes that may have influenced your business model?

MIMIR (Mustafa):
Our focus in researching the technology bubble was to answer a simple question: what companies survived and why? No matter if you look at the Dot Com bubble of the late 90s, the Railroad bubble of the 1880s or the Tulip mania of the 1630s, the lesson is that the underlying technology or asset still exists. Innovations from the technology bubble still power economic growth, railroads continue to connect and enable businesses, and tulips can still be found at your local supermarket.

The big takeaway was that companies focusing on infrastructure to improve and sustain the internet survived. Think about Amazon, Adobe, IBM, and Oracle. With the benefit of hindsight, we can see that (1) companies focused on short-term gains were severely challenged and many even failed, (2) investors can punish you fast, and (3) infrastructure-focused companies prevailed.

How does MIMIR apply some of these lessons to their own strategy?

MIMIR (Forrest):
Since the founding of the company in 2017, we have always focused on how to provide long standing value. Initially, we set out to create a particular decentralized application (a “DAPP”). We soon realized there were serious holes in the ability to create and deploy a successful DAPP. Specifically, the ability for end-users to seamlessly and securely acquire data from the blockchain presented itself as an immediate obstacle to adoption. Therefore, our mission at MIMIR was to solve the obvious infrastructure problem to make blockchain more accessible to everyone, including users of off-chain, edge-connected devices. We have gone to lengths to educate the general public, establish credibility, and form invaluable partnerships wherever applicable.

Not many people really understand the unique strengths and weaknesses of the blockchain security model, or when and how to leverage it effectively. It is our goal to change this.

Yes, but at the same time, there are numerous internet and database security companies out there and their services improve year after year. What should companies ask themselves if they are thinking about implementing a blockchain solution rather than today’s alternatives?

MIMIR (Mustafa):
Before answering, we wanted to dispel a certain myth about blockchain technology. It isn’t a silver bullet. This technology won’t fully replace most information security systems, but it can greatly improve security and efficiency for certain mission-critical systems. There are many potential costs to consider including the limited throughput of most blockchain systems, and the limited availability of skilled blockchain developers. A quick litmus test for whether an information system really needs blockchain might be (1) is it handling mission critical information, (2) do the rules around modifying this information need to be strictly enforced, and (3) can you afford relatively low throughput for these modifications? If you didn’t answer yes to all three, there are probably better alternatives.

As a valuation firm, one of the focal points of our work is to isolate key performance indicators of a business to determine future performance and risk. One of the difficulties we have seen is that people often conflate cryptocurrency with DAPPs, with blockchain technology, with computer stuff. In addition, the categorization of blockchain technologies is still quite elementary — unless you know the industry, it is hard to understand the competitive landscape. Can you please describe how value is generated in the industry and, more specifically, by MIMIR?

MIMIR (Forrest):
One of the critical discrepancies we often note when discussing blockchain technology, and specifically its application in cryptocurrencies, is that tokens/coins themselves do not generate value. Just like a security, the underlying assets generate value. Ultimately, just as Apple stock is determined by the performance of Apple’s assets, a token or coin’s value is determined by their respective assets (if you discount some of the more behavioral based trading).

We consider ourselves a middle-ware company that adds a second layer of security to enable companies to develop DAPPs and implement them for your everyday end-user. Our mission is to build a DAPP interface to improve the security and scalability of interactions with blockchain services from resource-constrained environments. Today, there are approximately 30 million Ethereum accounts but only about 30,000 nodes serving those accounts (we note that the figures presented include multiple account ownership as well as smart contracts). This illustrates the huge discrepancy between the number of users directly interacting with the blockchain and those using third-party services.

Our system acts as a decentralized blockchain API and content-distribution network, connecting end-users with those who can serve the information they need. We will pay individuals to host blockchain data and supply it via specialized security protocols. The individuals that supply and secure the data buy into our platform via the B2i tokens (written as an Ethereum smart contract), which also acts as a contractual agreement between MIMIR and the individual. Individuals will only be able to ‘work’ up to an amount commensurate with the tokens they secured as collateral. If said individual attempts anything malicious, the collateral can be revoked and redistributed to honest parties.

Finally, in terms of categorization, you are correct in terms of the difficulty given the plethora of facts and fiction out there about the blockchain ecosystem. There are current projects aiming to figure out categorization. We recommend reviewing Tech Crunch’s classification framework as an example.

Touching more on the topic of value drivers, can these technologies contribute to an enhanced bottom line? How can companies utilize blockchain technology to improve operational efficiency?

MIMIR (Forrest):
We are positioned to capitalize on the rapid expansion expected in the DAPP industry. As the industry matures, we expect for specific applications to be developed that can enhance value. The key driver of value for this industry will be the ability for users to acquire the right information and secure it as well. Specifically, there will be large growth in IoT based devices, Decentralized Applications, and secure platforms needed for a digital identity. All of these could benefit greatly from blockchain technology, most importantly infrastructure.

Another example can be found in industries with complex supply chains. For example, let us assume an aeronautical products company like Airbus. Given the specialized requirements for each of the components that goes into building an airplane, they must be sourced from all over the world. The length of time it takes to build and ship components, risk in transporting the components, and order of units received will all play into how quickly a company can build their airplane. Also, this information goes into planning for the project, such as hiring the necessary number of workers and other financing decisions. This is a scenario where the accuracy and auditability of information is paramount, and the latency of a blockchain is inconsequential. Given the number of moving parts, the inherent fault-tolerance of blockchain data stores is a plus too. This has applicability to many global industries.

Taking a step back, could you explain how and why blockchain technology is the future? There can so much buzz about new technologies that it becomes difficult to isolate true disruptive potential from ephemeral investment fads.

MIMIR (Mustafa):
In a world facing greater digital identity security needs, we believe that the blockchain technology offers enormous upside. This not going to happen soon given the lack of infrastructure (as well as security of that infrastructure). That is why this has become our primary focus to help create this “Netscape moment” — opportunity that brings about massive adoption through better user experience. Our goal is to help facilitate this Cambrian explosion of new Decentralized Applications, by providing the necessary tools and infrastructure needed.

To say it another way, we can relate this next technological wave to the advent of the internet. Initially, the internet was not as useful for commerce because you could not trust the other party. The advent of HTTPS added an extra layer of security. You could now securely verify the identities of the entities you interact with online. If the entity was reputable, you could choose to trust the information it gave you. Blockchain technology is the next step in the process. Where HTTPS allowed you to verify the identity of an entity, blockchains allow you to verify the state of a system. If we imagine a digital chess board, HTTPS can tell you who you are playing with, and blockchain can tell you where the pieces are.

Using another example, in Healthcare there is a known gap in electronic medical records and their ability to communicate with software across other clinics. If a patient wants to track their own records, it is a nearly impossible task to first aggregate the information and then store it for future use. Furthermore, these records are a form of intellectual property, but the value may not be fully realized given the information is often disorganized and incomplete. Adding a blockchain service to verify and secure this information would save time and hassle for both patients and businesses.

We are certainly looking forward to the vast possibility of blockchain infrastructure to be used in facilitating secure growth across industries. Some industries we are particularly excited about include: advertising, fintech, compliance, auto, voting, P2P markets, and more. Collectively it’s the vast potential for the use of blockchain infrastructure that MIMIR is excited to be a part of.

Mustafa and Forrest, thanks again for taking the time out of your schedule to talk with us. It was great to hear your insight into an early but rapidly growing field.

For readers, please feel free to reach out to Mustafa or Forrest with any questions about MIMIR Blockchain Solutions. We have left their information below along with theshort introduction video.

Contact Us

Forrest Marshall
Chief Technology Officer

Mustafa Inamullah
Creative Director

Website: MIMIRBlockchain.Solutions

MIMIR Blockchain Solutions

— — —

Daniyal Inamullah
Vice President


Policy & Procedures Checklist for Private Equity Investments in the Blockchain Industry


After the recent collapse of the cryptocurrency bubble, the appetite for institutional capital in the blockchain industry is still low, but there is an intensified focus on corporate governance, legal structure, and project teams. Investors looking to structure deals in the space need to implement appropriate methodologies for valuation and corporate governance to attract investors and create sustainable investment platform. EY’s recent study that 66% off ICOs are in the red has only increased the necessity to implement a systematic and conservative approach to investing in the space.

Don’t be caught off guard setting up proper controls for valuation policy & procedures. New valuation models such as the INET or NVT models require the assistance of experienced professions that are at the forefront of industry. Please reach out to Intrinsic today for more information!

Private Equity Checklist for Investing in the Blockchain Industry


Interest Rate Theory – Predicting a Federal Reserve Interest Rate Hike


In this lesson, we will discuss using futures data to predict changes in the federal funds rate. Changes in the federal funds rate have a critical impact on the yield curve, value of bonds, and economic growth. While this discussion will not go into depth for those topics, it will help you understand the relationship between investor expectations and how you can safeguard your portfolio. 

Gathering Information

The first step in predicting interest rate hikes is to gather information about current prices from the Federal Reserve and investor expectations from futures prices on the 30-day federal funds rate. In order to understand why futures are useful, please review the following:

  1. Investopedia Article on Federal Funds Futures
  2. Journal Article on Using Futures to Predict Rate Hikes
  3. Contract specs on the 30-day federal funds rate

Now, let’s start the process of gathering the data to make predictions! We are going to start with acquiring data from the Federal Reserve website. Specifically, we are looking for the current target rate set by the Fed. This is usually in the latest minutes released by the Fed. If we navigate to the FOMC calendar on the Fed’s website:

Find the last FOMC meeting and review the PDF, the header and relevant sections can be seen below:

Here, we can see that the current target federal funds rate is 1-1/14 (meaning 1.25%). The next step is to find the latest futures price on the 30-day federal funds rate futures. We first navigate to the CME group site for the 30-day Federal Funds Rate (the easiest way to do this is to just google that term). 

This page shows the current quotes; however, we want a more stable figure to help us in our analysis. Click on the Settlements to see finalized settlement prices from the prior business day. 

Here, we can see that the last settled price is 98.8425. According to Robertson and Thornton (Click here to access paper), the futures quite can be thought of as the average price for Fed funds in a particular contract month. 

In this case, the implied yield on the federal funds rate can be calculated as 100 – 98.8425 = 1.1575%

The last piece of the puzzle is to note the date of the next FOMC meeting and select the appropriate futures instrument. Above, we have selected the November futures price (although this should usually be determined afterwards). Looking at the FOMC calendar meeting, we observe that the next FOMC meeting is October 31, 2017. Therefore, we selected the futures instrument with the nearest maturity to the next FOMC meeting, and represents the most relevant instrument to gauge investor sentiment. 

Putting it All Together

Using this information we gathered, we can apply Geraty’s formula to determine the probability of an increase in a federal reserve hike (click here to access the article). The other key factor is what the expected rate hike will be. Based on the information above, we see that the implied yield of 1.1575% exceeds the federal funds rate target of 1.25%; therefore, we can determine that investors are not expecting an increase in the federal funds rate. Instead, let’s examine a 25 basis point reduction. 

The formula is presented below, in addition to the application of the inputs gathered above. 

Based on the analysis, there is an 8.0% probability of a reduction in interest rates. From an investor’s perspective, this implies that the federal funds rate is unlikely to change at the next FOMC meeting!


Keeping in mind there are adjustments to be made to the formula (read the literature I have posted links to!), this is a simple way to gauge investor expectations. This strategy becomes even more powerful when combined with your own interest rate projections, topics we will cover at a later date!

Bond Investing Basics – Duration


Today, we will talk about the concept of duration. The discussion will include a basic overview of the concept of duration, different methods to calculate duration, and how to incorporate duration into both strategy and risk management.

What is Duration?

Duration measures the sensitivity of a bond’s price to changes in interest rates. Since bond prices have an inverse relationship to bond yields, an increase in interest rates will reduce a bond’s price (and vice versa). For a more basic overview, please visit “Bond Investing Basics – Setting Your Goals” for links related to basic bond concepts. Duration measures (or, more precisely, attempts to estimate) the magnitude of that change.

How to Find Duration

Most brokerage firms that allow you to trade bonds have both screening tools and tearsheets in order to find a suitable bond based on the desired level of duration. Below, I have used the E*Trade platform to find for a position’s duration. First, click on Trading –> Bonds to pull up the Bond Overview page.

In the box labelled “CUSIP,” (CUSIP stands for Committee on Uniform Security Identification Procedures and represents a 9 digit identifier for bonds) type in any identifier for the bond. For the purpose of this post, we have used the CUSIP “665859AL8,” which is a CUSIP for a bond issued by Northern Trust Corp.

From here, click on the actual issue (in this case, it is clicking on “Northern Trust Corp” in the Issue column) to bring up further details on this specific bond. Looking at the bottom right, you can see the Macaulay duration to be 2.848.

There are a few different measures for duration outlined on this page (in addition to convexity, which we will not be covered today), that we will cover in a later post. The duration figure represents the number of years it will take an investor recover the cost of a bond (after accounting for discounting, the purchase price, and remaining cash flows). The higher the duration, the higher the interest rate risk. Generally speaking, a bond’s duration will be higher with:

  1. Higher interest rates
  2. Longer maturity
  3. Lower bond prices

One general strategy is to consider where interest rates are expected to move in the future. If an investor expects interest rates to move up (hence, prices to move down), he or she may consider “shortening” duration in order to reduce interest rate risk. This will make the bond portfolio’s value to be more resilient to increases in the interest rate. If an investor expects interest rates to decline (hence, price move up), he or she may consider “lengthening” duration in order to take advantage of a bond’s sensitivity to interest rates. The most sensitive the portfolio is, the more likely that the bond’s price will move up.

Risk Management

The first step in the process is to determine what you can benchmark your portfolio to. There are several different benchmarks released by companies such as S&P, Merrill Lynch, etc. In addition, the benchmarks can be tied to the tenor of bonds, industry, credit rating, structure, etc. Using more specific benchmarks can help investors tie their performance and uncover key drivers of under or over performance. As an example, for the purpose of our post, we will be using the general S&P US Aggregate Bond Index (click here for the S&P summary page). As indicated in the name, this index represents broad coverage of US-based investment grade fixed income. First, click on “Factsheet” and then download the Month-End report.

After, flip to page 3 of the downloaded document where you can find the index characteristics below:

As you can see, when comparing to the Northern Trust Corp. specific data, the general US investment grade market has a higher duration (5.50 versus 2.848).  While we have just used the duration figure here, you will be able to benchmark a few factors relative to the general index (such as yield, tenor, etc.). A more appropriate benchmark to Northern Trust Corp. may have a portfolio duration closer to the subject company.

Risk Management Modelling

Please download the duration model here

This model is intended to provide a broad view of how to manage duration risk in a portfolio. We start off with noting key elements of your bond portfolio (such as the invested amount, price per bond, maturity date, and the coupon rate). The model automatically calculates the duration (using the Macaulay formula) and the implied yield on the bond. After all the individual data has been input, the model will calculate the portfolio figures in the bottom row:

From here, we can calculate potential changes to each position. Changes in the price, based on the duration of the bond is generally presented as:

Change in the Bond Price = Duration * Change in Yield

The sensitivity table below shows the percentage changes in the bond price based on assumed changes in interest rates:

Based on this analysis, investors can choose whether or not they need to adjust the portfolio for expected changes in the interest rate in the future (i.e., to take advantage of declining interest rates by lengthening duration or vice versa).

Just to note, the model is a simplified tool. In order to truly understand your portfolio, adjustments would need to be made for:

  1. Amortization or cash flow sweep payments (the model assumes a bullet payment)
  2. Interest Payment dates if anything other than quarterly payments
  3. Call or Put options embedded in the bond structure
  4. Unique structures

Another way to look at the model’s output is to determine the total dollars at risk. If you expect for rates to decline 2% over the next year, you can see the potential impact to your portfolio. Investors can find ways to hedge the portfolio or change strategy. Again, investors need to pay attention to their specific strategies; the model is just a tool to help you along the way!


Duration is a foundational concept to understand when building your bond investment strategy. Bonds have a built-in structure that enables investors to have more clarity relative to general equity investments. Taking advantage of these structures may be difficult to understand, but are rewarding to figure out!

Bond Investing Basics – Credit Ratings


Today’s lesson will focus on credit ratings and how to utilize them in order to manage your portfolio and potentially select strategies that will enhance returns.

Credit Rating Definitions

There are generally two credit rating agencies that investors pay attention to: Standard & Poor’s and Moody’s. Credit rating categories range (in the case of S&P) from AAA (highest rating) to D (lowest rating). See below for each company’s credit categories and corresponding definitions:

  1. Moody’s
  2. S&P

One important consideration is the separation of “investment grade” and “high yield” bonds. Investment grade bonds (categorized typically as AAA through BBB rated bonds using the S&P categories and Aaa through Baa3 using the Moody’s categories) are generally “safer” investments than high yield bonds. More risk, in the case of bonds, refers to the increased probability of default. Given this perspective, a few key differences exit between the two:

  1. Investors will demand a higher expected return high yields to make up for the additional risk of the investments. Please refer to our latest market update to see the yield differentials for each credit rating.
  2. High yield instruments will generally have more restrictive financial covenants set by lenders. Breach of the covenants could lead to an increase in the interest rate, triggering of additional fees, or even be considered an event of default (in which case the lenders may choose to take control of the assets to either replace the management team or sell the assets in order to recoup their principal).
  3. Given the greater yield on high yield instruments, these bonds will experience greater volatility and sensitivity to movements in interest rate changes. From the lesson on the relationship between bond prices and yields (namely, they are inversely related), the magnitude of the impact of changing yields will be greater for riskier investments. This is measured by ‘duration’ and ‘convexity’ (we will discuss these in later posts).
  4. The maturities of investment grade bonds are typically longer given the relative trustworthiness of the company.

Risk Management

There are generally two ways to incorporate credit ratings of bonds into risk management strategies.

First, for a portfolio of bonds, each individual bond will typically have an individual credit rating. Based on a weighted average approach, an investor can view the overall risk of the portfolio by calculating an assumed “portfolio credit rating.” There are two steps in this process.  

Assign an ordinal indicator to each credit rating category. For example, in the case of S&P credit ratings, we have assigned a figure to each credit rating category:

Next, we can find the assumed numerical weighting based on the credit rating of each bond. In the chart below, we have inserted random credit ratings to the dollar amount of each individual bond. Based on the weighted average of each portfolio position (dividing each holding amount by the total dollar amount held) and the numerical rating of each position, we can estimate the weighted average contribution in the “Weighted Avg Rating” column. After summing all of these rating contributions, we calculate a numerical rating of 3.8 for the portfolio. Looking back above at point 1, this implies a credit rating in between A and BBB.

The second way to incorporate credit ratings into risk management is by observing changes over time. Over time, as credit ratings increase or decrease, the investor can make adjustments to fine tune the portfolio. For example, in the case above, if the investor wants to keep a rating of A as the minimum for the portfolio, they may consider selling lower rated bonds (such as Bond 6, Bond 3, or Bond 4) and purchasing other bonds with higher credit ratings.

Total Return Perspective

One key element of utilizing credit ratings is to find potential cases where an investor believes a bond will receive a credit upgrade in the future. For example, a bond may be upgraded from a BBB to an A. Ratings upgrades occur when recent performance, the macroeconomic backdrop, or some other factor occurs and the credit rating agency determines it has materially lessened the company’s probability of default. For example, see the link here for a recent Moody’s upgrade of Anglo American.  

When this occurs, investors are willing to acquire the bond at a greater price given the risk reduction in the position. The key to this strategy is to predict when and if a company will experience a ratings upgrade. If an investor is successful with this strategy, they are able to lock in a higher return by selling the bond at a higher price than they acquired it for.


Credit ratings are an important component of risk management and bond investment strategy. Investors must be aware of various strategies they can deploy to take advantage of changes in the company’s rating. For example, a recent rating downgrade may provide an investor to take advantage of a lower price. However, the investor must be willing to either take on the additional risk or believe that some change will occur to reverse this trend sometime in the future.

Bond Investing Basics – Setting Your Goals


In this section, we will discuss setting goals for investing in bonds. This section is not designed to give you a primer on bonds given the plethora of sources out there that provide sufficient overviews (I have provided links to some of the better ones below). Instead, we will focus on the key components of choosing an investment that matches your personal goals and strategy.

Background Knowledge

If you do not have a good background in bond investing, I suggest reading through the following sources:

  1. Investopedia – “Bonds”
  2. The Motley Fool – “How to Invest in Bonds: A Step-by-Step Guide”
  3. Project Invested – “What Factors Should You Consider When Investing in Bonds”

Furthermore, if you are not interested in investing in individual bonds (given the time and knowledge commitment required to get there), review some of the differences in investing in bonds and bond funds below (my only specific suggestion is to play close attention to bond fund fees, that could also be a critical factor outside of the actual management of the portfolio):

  1. CNBC – “Bonds vs Bond Funds: What you Need to Know Now”
  2. Fidelity – “Bonds vs Bond Funds”
  3. The Balance – “Investing in Bonds versus Bond Funds”

Setting Goals for Bond Investing

The sheer size of the global bond market (estimated to be over $100 trillion) provides investors with numerous investment options. Some of these investments have traditionally been seen as “safer” than investing in stocks. Some of these investments have funky features (such as call/put options, conversion features, etc.). Some of these investments provide certain tax advantages (e.g., municipal bonds). As part of your investment plan, we will focus today’s discussion on a few items:

  1. Time Horizon
  2. Risk Taking and Risk Management

Time Horizon

Bonds can be structured to have short-term maturities (0-5 years), medium-term maturities (5-10 years), and long-term maturities (10+ years). Different investors may differentiate the categories for maturity length, but this summary should suffice to get the point across.

In the case of figuring out your time horizon, it can be as simple as counting the years until your child goes off to college to as difficult as figuring out how many bonds you will need to provide income through your retirement. A few suggestions:

  1. Be honest and conservative in your assumptions
  2. There are always multiple time horizons for your savings plan, make a plan for each one
  3. Think about potential scenarios where you may need money
  4. Think about inflation over the long run and if it will impact your time horizon assumptions
  5. Your emergency fund is your best friend, time horizons are meaningless if you do not have a reserve in case the market drops really fast

Risk Taking and Risk Management

For individuals entering into retirement, traditional investment theory dictates most of your portfolio should be allocated towards investment grade (discussed below in the risk taking and risk management section) bonds. A rule of thumb often portrayed is to subtract your age from 100 to determine the percentage allocation in your portfolio (e.g., if I am 75, then 75% of my portfolio should be in bonds).

However, as you will often note, real world application of finance theory often falls flat in real world applications. For example, if the size of the portfolio relative to retirement needs is quite large, an investor will often elect to invest more in stocks in order to potentially maximize their estate. In addition, different portfolios may have different goals, such as saving for an expensive purchase (Harley or a boat), children’s education, or an emergency reserve.

Although we will discuss some of the strategies in later posts, here are some of the risk-based items you will need to think through:

  1. Credit Rating / Default risk – What is the rating of the company and where do you expect this to trend in the future or over your time horizon?
  2. Credit Spread relative to comparable credits and market indices – Are you getting a good deal at the price you are paying?
  3. Financial and operating leverage of the company – Can small swings in the company impact your investment?
  4. Industry of the company – What are certain industry drivers and what part of the business cycle is the industry currently experiencing?
  5. Duration / Interest rate risk – How quickly will rates rise (obviously you will need to consider the opposite as well, but our low interest rate environment contributes to this specific discussion)?
  6. Inflation risk – Is nominal or real return more important to you?
  7. Liquidity – Will you be able to sell when you need to?


There are obviously a lot of factors to consider when setting up a strategy. The issue some investors have is that they read online for various bond investing strategies and try to fit their personal situation to fit the strategy. Rather, you should think more about your situation and pick the appropriate strategies to meet your goals. This will also allow you to make the right sacrifices, correctly set your risk parameters, and focus your attention on specific details you will need to succeed.