The left-hand table shows a variety of hypothetical zero duration core plus blends. Compared to a traditional approach, investors are able to reduce their portfolio duration to zero at a cost of 1.37% per year. While this portfolio sacrifices approximately 44% of its income potential, interest rates would only need to rise by approximately 27 basis points (bp) over the course of a year to break even. If investors believe that rates could rise by more than this amount, hedging could potentially add value.
Turning our attention to the table on the right, we see that investors can have a greater impact on the duration of their portfolio when they blend exposure with a negative duration core plus strategy. However, this approach may be more sensitive to distortions in the shape of the yield curve. Since this strategy is constructed through selling longer-duration securities, a rise in interest rates might be possible, and investors’ hedges may not immunize their portfolio from losses resulting from these higher interest rates. However, for investors with a stronger conviction about rising long-term interest rates, a negative core plus strategy can provide positive income potential with a negative duration position of more than five and a half years. This approach could allow investors to essentially finance their negative interest rate bet, compared with the negative carry associated with shorting bonds outright.
Ultimately, investing is largely about tradeoffs. As we highlighted earlier, we believe that our suite of rising rate strategies can provide powerful tools for investors seeking to manage risk in their portfolio. By striking the appropriate balance between credit and interest rate risk, we believe that these approaches may help add value to investor portfolios as the Fed begins to normalize its monetary policy.
Important Risks Related to this Article
There are risks associated with investing, including possible loss of principal. Non-investment-grade debt securities (also known as high-yield or “junk” bonds) have lower credit ratings and involve a greater risk to principal. Fixed income investments are subject to interest rate risk; their value will normally decline as interest rates rise. The duration Funds seek to mitigate interest rate risk by taking short positions in U.S. Treasuries, but there is no guarantee this will be achieved. Derivative investments can be volatile, and these investments may be less liquid than other securities and more sensitive to the effects of varied economic conditions.