Team Favorite At the Money: Managing Bond Duration
Jan 1, 2025
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Karen Veraa, Head of iShares US Fixed Income Strategy at BlackRock, dives into the intricacies of managing bond duration in a fluctuating interest rate environment. She discusses the challenges posed by rising and potentially falling rates and examines how these affect bond performance. Veraa shares strategies for investors, including the benefits of bond ladders and rethinking cash positions. Additionally, she explores the impact of Federal Reserve rate hikes and the advantages of locking in long-duration bonds as a response to market volatility.
Understanding bond duration is essential as it reflects the relationship between interest rate changes and bond price volatility, highlighting risk exposure in bond investments.
With the Federal Reserve signaling potential rate cuts, investors are encouraged to reassess strategies, including adopting intermediate-duration bonds and creating bond ladders for optimized yield.
Deep dives
The Importance of Duration in Bond Investment
Duration serves as a crucial measure of interest rate risk for bonds, indicating how much a bond's price is likely to change in response to interest rate fluctuations. For instance, if a bond has a duration of five years, a 1% increase in interest rates would typically result in a 5% decrease in its value. Understanding this relationship helps investors gauge their exposure to interest rate changes and manage risks effectively. Different types of durations, such as key rate durations and credit spread durations, further refine this understanding, allowing investors to make more informed decisions tailored to their risk tolerance.
Impact of Rising Interest Rates on Bonds
The period of rising interest rates, particularly from March 2022 onward, significantly impacted bond performance, with long-duration bonds experiencing substantial losses. In 2022, the broad taxable bond market saw a decline of approximately 13%, while long-term bonds lost over 20% in value, marking one of the worst years for bonds in decades. This performance decline can be attributed to the Federal Reserve's aggressive rate hikes aimed at combating rising inflation post-COVID. Such historical context serves as a reminder of the volatility that can occur in fixed-income investments during periods of significant rate changes.
Strategizing for Future Rate Cuts
As the Federal Reserve signals potential rate cuts, investors are prompted to reassess their cash positions and consider transitioning into intermediate-duration bonds for better returns. With yields on money market funds now appealing, many investors are building bond ladders to capitalize on future opportunities as the yield curve normalizes. While there is uncertainty regarding the timing and extent of rate cuts, the current investment strategy emphasizes locking in attractive yields before they diminish. Furthermore, incorporating longer-duration bonds can serve as a hedge against equity market volatility, smoothing overall portfolio returns during economic fluctuations.
How should investors manage bond duration in an era of rising – and soon likely falling – interest rates?
The challenge is that the longer the duration your bonds are, the higher yield usually is, but the more vulnerable those bonds are to rising rates. When rates fall, long-duration bonds go up (shorter duration much less). There are many ways investors can take advantage of changing interest rates. For more on the subject, Barry Ritholtz speaks with Karen Veraa, Head of iShares US Fixed Income Strategy at BlackRock.
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