Bond Duration
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Written by: 2022 was the worst year on record for bond investors. The main culprit? Bond duration risk. Duration helps measure how sensitive bonds are to interest rate moves. There are different types of duration, and ‘modified duration’ provides investors with a simple rule-of-thumb tool for gauging one’s own sensitivity to interest rate risk.
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Example (ceteris paribus!)
The bond-price seesaw
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Duration works like a seesaw – as yields rise, prices fall. So make sure to get the sign correct in the calculation above. The impact is intuitive: the further from the pivot you sit, the bigger the swing in bond prices. Imagine getting a friend to jump onto the end of a seesaw as you sit at the opposite end – it makes for quite a ride!
In 2022, yields rose around 2%: Short-dated investment grade (i.e. high quality) bonds (duration ~3 years) fell c5.8%. Investment grade bonds of all maturities (duration ~7 years) fell c14.1%. The maths checks out! Both are diversified bond asset classes, but both experienced very different outcomes. These decisions matter. Taking the time to understand the impact of decisions that you make – or whoever is responsible for investment decisions made in your firm –is evident.
It’s all about preference! What goals are you looking to achieve with your investment programme? What are your constraints? Getting answers to questions like these helps build a confidence in a solution recommended and gives the opportunity to offer better outcomes for clients. If you get the gist of what we’re talking about, but maybe want to feel more confident, especially in front of your clients, get in touch with our team. Bond return proxies (these are provided for example purposes only and does not constitute any form of recommendation): Vanguard Global Short Term Bond Index Fund Hedged GBP – Vanguard Global Bond Index Fund Hedged GBP |
An example of bond maths in action
So what is the correct allocation?