But you also most consider what if rates don’t rise, then what? It seemed the short duration investing was the big trend heading into 2013 as virtually everyone thought rates were going to rise, and the trend hasn’t abated as the year has progressed. However, that rate increase hasn’t played out, as rates on the 10-year Treasury ended 2013 at 3.04%, and now sit around 2.2% today.
As noted above, duration is a measure of price change based on a change in interest rates, and that price move works in both directions: a theoretical price decline if rates rise as we have profiled above, but also a theoretical price increase if rates decline. So in an environment such as we have seen so far this year, with rates declining, then the higher yielding portfolio would not only benefit from the higher starting yield but a theoretical positive price movement per the duration calculation.1
So we see this as compelling evidence that investing purely according to a short duration strategy and not factoring in yield is not necessarily the wisest way to approach this market and the seemingly ever present interest rate concerns. At the end of the day, yield matters. A higher yield can go a long way in making up for relatively small differences in duration. Furthermore, even if rates do rise, it very well can take longer than many expect (many were certainly wrong on how 2013 would play out!), making the argument for the higher yielding portfolio versus the purely short duration portfolio even stronger.
1 The duration and price movement relationships are approximates and calculations are provided for illustration only. These calculations assume that credit spreads remain constant and do not factor in any fees or expenses or changes in price movements for other reasons, including security fundamentals, etc. Actual results may be materially different.
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).