A little more complicated than just duration

With the prospects of rising interest rates in the UK and the US and continued uncertainty in the market more generally, many investors are looking to shorten the duration within their bond portfolios.

A little more complicated than just duration


But, while the strategy has a lot of merit, duration should depend on the market being looked at.

According to Teresa Kong, lead manager of the Matthews Asia Strategic Income Fund, in a world with asynchronous rate regimes, duration is a complicated subject.

"From a strategic point of view, the level of duration that is appropriate depends very much on which interest rate regime you are in, in the US or the UK, shortening duration makes sense, but in an area like the EU for example, it doesn't make as much sense."

Nick Gartside, international CIO within JP Morgan’s global fixed income group agrees saying that the message is definitely that central banks are back.

“You have a much more assertive European central bank, the Bank of Japan is becoming more activist and, on the other side, you have an expectation that the Fed is going to become increasingly activist, but in the other direction,” he says.

This divergence and increased activism on the part of central banks also has another implication, beyond the impact on duration, says Gartside.

“In a sense there are two sorts of markets, directional markets where big trends are visible, and markets where there is a lack of big trends, where trend growth is low. Arguably we are heading toward the latter sort of market at the moment.”

While rates and bond yields are going to go up in the US and the UK, Gartside adds that this lack of pronounced long run trends, requires a subtle mindset shift on the part of bond managers – the focus needs to shift from capturing big momentum gains to manufacturing capital gains.”

He adds: “You need to be more dynamic, especially in terms of bond benchmarks which have an implicit style bias, they are predominantly long duration and the question now is that where you want to be?”
Currently, he says, the group has trimmed duration slightly to 1.5 years and is underweight US treasuries, while remaining overweight high yield, by isolating between the spread.

The risk to high yield is that default rates go up, and we don’t see that as especially likely yet.