A Closer Look: Short, Medium and Long Duration
Now that we have the duration concept down, let’s take a look at some actual ETFs to get a sense of their durations and performance. When we say short duration, we are generally referring to bonds that mature within three years. A short duration strategy tends to have lower yield than a long duration fund, but in a rising interest rate environment a short duration fund will experience less price loss. An example of a short duration fund is the iShares 1-3 Year Treasury Bond ETF (SHY), it has a duration of 1.84 years. Given this low level of duration, SHY held up fairly well in 2013, returning 0.23%.
Intermediate duration funds generally hold bonds that mature within 3 to 10 years. Yield is higher than with short duration funds, while interest rate risk is lower than long duration. An example of an intermediate duration fund is the iShares 7-10 Year Treasury Bond ETF (IEF). This fund has a duration of 7.53 years, and as a result returned -6.12% in 2013 as it was more impacted by rising rates than SHY was.
Long duration bond funds generally have a maturity of more than 10 years, and usually offer the highest interest rates, making them the optimal choice in a falling rate environment. However, in a rising rate environment long duration funds can experience sharp price declines. An example of a long duration fund is the iShares 20+ Year Treasury Bond ETF (TLT). This fund has a duration of 16.38 years, and as a result returned -13.91% in 2013. As you can see, during a period of large interest rate movements, the duration of a bond investment will often drive its performance.
A Duration Strategy for 2014
As my colleague Russ Koesterich highlighted in the recent Investment Directions, we expect intermediate interest rates to continue to rise during 2014. This makes intermediate duration funds likely less attractive than shorter duration funds.
Matt Tucker, CFA, is the iShares Head of Fixed Income Strategy and a regular contributor to The Blog. You can find more of his posts here.