Duration is a measure of interest rate sensitivity, and takes into account yield. Though there are different ways of calculating duration, it is broadly defined as the effect a 100 bps (1.0%) change in interest rates would have on the price of a bond. One would think that if the currently low yields by historical standards were to dramatically change our interest rate sensitivity going forward, that would be reflected in the duration number. But as the graph above indicates, we are not seeing an elevation of duration.
However, on the flip side, we are seeing a portion of the market that is at very tight yields, so the usual benefit that a higher starting yield the can help cushion the rate change does not hold water for this segment of the market. The following chart depicts the issue.2
The highest rated piece of the high yield market, split BBB has a duration over 1 year longer than the next two highest ratings categories (BB/Split BB). Then once you get down to B rated securities and below, you are looking at about another year decline in duration. We see this split BB to split BBB portion of the index as trading more along the lines of investment grade, which does have a positive correlation to Treasuries and has historically performed well under that of the high yield market during periods of rising rates (though still a positive performance, see our blog “High Yield in a Rising Rate Environment: A Perspective on Historical Performance”). When we talk about tight yields, this highest rate portion of the high yield index exemplifies the issue, trading at a yield to worst of 3.81% for split BBB and 4.3% for BB rated bonds, bringing down the broader index statistics.
This is why active management within the high yield market is essential. Active managers are able to avoid the quasi-investment grade names that trade at very low yields and higher durations, the credits that we would expect to be much more impacted by interest rate increases, and take advantage of credits that are at seemingly attractive levels.
1 Modified duration for the Credit Suisse High Yield Index for the period of 1/31/2000 to 8/31/2014. The Credit Suisse High Yield Index is designed to mirror the investible universe of the $US-denominated high yield debt market.
2 Modified duration for the Credit Suisse High Yield Index based on the designated ratings categories as of 8/31/2014. The Credit Suisse High Yield Index is designed to mirror the investible universe of the $US-denominated high yield debt market.
This article was written by Heather Rupp, CFA, Director of Research for Peritus Asset Management, the sub-advisory firm of the AdvisorShares Peritus High Yield ETF (HYLD).