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HOME >Portfolio De-Risking: Negative Duration

We described in “Non Beta Investing: the Ugly Duck. For now.“, how the big hands of central banks, as well as the big but weak hands of mammoth – compared to their target markets – ETFs and mutual funds scoop any public and liquid asset, driving prices up. After eight years of quantitative easing, the reflation of asset prices still has not been transmitted efficiently into economic reflation, although we don’t really know how the economy would have fared without it. At this point in time it seems that central banks are steadily becoming aware of their contribution not only to the imbalances in asset prices but also in the political act. At the same time, there is no doubt to us that inflation is picking up, not only in obvious places like the UK but also here in the US. There will be strong reluctance for continuation of QE. We expect that in places like the UK but also the US (depending on the scope of dollar strengthening) there will be need for rate increase.

Therefore, we believe that the next quarters will look different.

Negative duration

For many years we have emphasized the importance of investment solutions that have negative sensitivity to interest rates, effectively exhibiting a negative duration. One way to approximate statistically sensitivity to rates is through factor analysis, as presented in the chart below. The interest rate risk factor is modeled as the US Government 5-10 Years Credit Index spread over T-bills. We can observe in the chart how both investment grade and high yield fixed income indices present significant positive sensitivity to rates (positive duration), which means their price is adversely affected by increase in interest rates.


Source: Core Capital Management


The value of duration can be approximated from this chart considering that the US Government 5-10 Years Credit Index has roughly 7 years duration. It follows that Barclays Aggregate has an approximate duration of 5 years (0.7 sensitivity times 7 years), ML HY Index approx. 3 years (0.4 sensitivity times 7 years). The chart presents rolling sensitivity measured on a 48-month rolling basis, capturing therefore the long term trends. Note that the steady increase in Barclays’ Aggregate Index duration, another hidden risk of indexing investing, is captured even in this simple framework.[1]


Investors should always look for solutions that act as de-risking tools in their portfolios. In particular, those who are not in the bull bond camp should diligently look to mitigate duration risk. However, this is easier said than done. Many, if not most candidate solutions may indeed mitigate duration risk, but would add significant volatility to the overall portfolios. Solutions with negative duration which, at the same time, exhibit low volatility and present intriguing upside are rare. They will prove invaluable for many portfolios.


– Sorina Zahan, Ph.D.


[1] A 48-month rolling analysis will tend to underestimate the current value when the shorter term trend is upwards and overestimate when the trend is downwards. A shorter term analysis shows a higher duration for IG (5.5 years) but overall is also less significant statistically.

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