Investors should keep in mind that moving to shorter duration bonds may come with some unintended consequences. Since shorter maturity bonds have a lower yield, the returns may not keep pace with inflation. After inflation, which has been trending around 2%, investors may be getting negative levels of yield. Also, for investors with income needs, a short duration bond portfolio may not generate enough yield to achieve their goals.
An additional challenge with trying to position for rising interest rates is that all rates do not move in tandem, short term interest rates can move independently from intermediate and longer term interest rates. Strategies that appear to reduce interest rate risk could actually underperform in a rising interest rate environment. How you go about reducing interest rate risk, and which interest rates you protect yourself against, will ultimately determine the success of your strategy. I will talk more about this in a later post and discuss how to think about positioning in different rising rate scenarios.
With ETFs, shortening duration in fixed income portfolios can be efficiently implemented across a variety of sectors. Before undertaking such a strategy, make sure you understand the trade-offs between buying short and longer maturity bonds.
Matt Tucker, CFA, is the iShares Head of Fixed Income Strategy.