5 Key Questions on Duration
The first half of 2022 was the worst on record for many major bond benchmarks, which recorded double digit losses. Negative returns were the result of high levels of duration exposure in conventional portfolios, as central banks either started or foreshadowed aggressive monetary policy tightening to combat the highest level of inflation in decades. The size of drawdowns in duration-heavy portfolios, high bond volatility and commensurate weakness in riskier assets, led many investors to question the role of government bonds in broader portfolios.
At Ardea Investment Management, we have long believed there is more to fixed income than buying bonds for yield. We adopt a pure relative value investment approach that aims to be independent of the level of bond yields, the direction of interest rates and the macroeconomic factors that dominate the performance of conventional investments. Ardea explicitly avoid active duration risk as part of our investment process (see here for further discussion on how various fixed income strategies are impacted by the market environment).
However, as participants in global fixed income markets, many clients ask us questions on duration, and the outlook for bonds. While we don’t use, or provide forecasts for bond returns or yield levels, we can offer some frameworks for thinking about duration in the context of current market dynamics and a multi-asset portfolio.
In this note, we answer these five key questions on duration:
- Is the worst period for bond performance behind us?
- Are investors compensated by risk premia in the current environment?
- What is the role of bonds in a multi-asset portfolio?
- Is there more to a duration decision than yield levels and correlation with equities?
- What is an appropriate framework for allocating to government bonds?