It Really Is Time To Understand Duration

June 25, 2015

This article is part of a regular series of thought leadership pieces from some of the more influential ETF strategists in the money management industry. Today's article is by Larry Whistler, president and chief investment officer of Buffalo, New York-based Nottingham Advisors.

 

As the Federal Reserve embarks on its long-awaited interest rate “normalization” voyage, portfolio managers need to prepare their portfolios for the journey. As passengers on this ship, intended or not, bond holders everywhere will feel the sting of rising rates for the first time in nearly 10 years.

 

We’ve noticed a certain complacency having set in in the fixed-income arena, with few investors properly acknowledging that, indeed, one can lose money in bonds!

 

 

Five Big Bond ETFs

The largest fixed-income exchange-traded funds by assets are:

 

That’s more than $100 billon invested in those five ETFs alone. Although hardly identical, they all share one measure that investors should be focusing on right now: duration.

 

Duration, Up Close

A bond’s duration measures its price sensitivity to changes in interest rates. A bond with a duration of five years, for example, will suffer a 5 percent price decline should interest rates rise 1 percent. The same principle applies to fixed-income ETFs as well.

 

  Average
Coupon
Average
Maturity
(Years)
Effective
Duration
(Years)
 
Yield
 
Average
Daily
Volume
Expense Ratio
(%)
U.S. Aggregate Bond (AGG) 3.26% 7.3 5.2 2.28% 1.9 MM 0.08
Vanguard Total Bond Market (BND) 3.30% 7.9 5.7 2.46% 2.1 MM 0.08
Vanguard Short-Term Bond (BSV) 1.90% 2.8 2.7 1.32% 889.3 K 0.10
iShares Investment Grade Corporate Bond (LQD) 4.26% 12.2 8.0 3.42% 3.2 MM 0.15
iShares High Yield Corporate Bond (HYG) 6.39% 4.9 4.2 5.37% 6.4 MM 0.50

Source: Nottingham Advisors

 

As mentioned at the start of this post, it’s been nearly 10 years since the Fed raised the federal funds rate.

 

That said, we’ve had periodic interest rate spikes, but a longer, more sustained advance in interest rates hasn’t happened in over 30 years. Since the start of February, however, the 10-year U.S. Treasury note has seen its yield spike by 74 basis points—a 44 percent move higher!

 

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