Potential Tradeoffs
Although the Fund seeks to target a negative five-year duration, an increase in rates of 100 basis points does not necessarily guarantee a 5% price return. Given that interest rates may rise at different speeds along various points of the yield curve, it may be possible that the targeted negative exposure is not effective at offsetting losses from long bond positions. Additionally, should rates remain constant (or fall), the strategy may underperform a long-only portfolio. However, given the low cost of this insurance in today’s market environment, we believe that the potential upside for rising rates outweighs the potential losses in carry from putting on this exposure.
A Summary of Bond Yields and Durations as of November 30, 2013
For definitions of terms and indexes in the chart above please visit our Glossary.
As we have shown, investors have a variety of ways of attempting to mitigate the impact of rising rates on their bond portfolios. As another tool for reducing overall interest rate risk in a portfolio, strategies with a negative duration exposure can be used not only as a standalone tactical investment, but also as a way to help offset interest rate risk across their broader fixed income portfolio.
1Investors have also sought to increase credit risk in their portfolios as a way of reducing interest rate risk, but we are attempting to only focus on the impact of higher rates.