Fixed-income investors are stacking up short-term bonds while unloading longer-dated term debt, in order to shield their portfolios from the possibility of the worst of a market rout as interest rates spike up. The move is a sharp reversal from the previous year, when investors stockpiled into a longer-dated debt to confine the higher yield which companies sold in record amounts of the said long-term bonds.
US investors have placed $5.2 billion in short-term bonds since the start of the second quarter, at the same time, pulling $3.1 billion from intermediate and long-term funds. The inflows into short-term funds have amounted to $8.6 billion while $2.2 billion has come out of funds devoted to longer-maturity bonds.
Longer-term bonds ideally sell off most sharply as market rates increase as they have done since it became clear that the US Federal Reserve would soon begin to slow down its purchases of Treasury and government-backed mortgage bonds.
For the last few years, there hasn’t been really that many investors who experienced corporate debt in hedging their duration. But now, a lot of people want out of the duration risk in fixed-income that they weren’t necessarily aware they previously had.
Duration is basically the measure of how sensitive bond prices are to change in interest rates, which takes into consideration account maturities and interest payments. The lower is the duration, the lesser a bond’s price may eventually fall if the rates increase.
Rushing into short-term debt could be short sighted and that there is an opportunity cost of buying short-dated bonds. The Fed gave its word in keeping short-term rates exceptionally low even as it tapers the longer-term bond purchases.
The turnaround in bonds “definitely changes the way we look at products that have plenty of interest-rate sensitivity. One helpful strategy is to minimise rate sensitivity in fixed-income portfolios into floating-rate debt, loans and portions of the commercial mortgage market and to assets from regions such as Europe wherein monetary policy could stay loose for a long period of time.
As a general rule, a fund with a duration of 10 years might probably see a 10 % drop in the value of its holdings for each 1 % increase of its rates.