Bond Fund Duration May Overstate Rate Sensitivity
Over the last year, we found that bond funds were less sensitive to rates than their reported durations would suggest.
In November, my colleague Eric Jacobson published a Fund Spy article entitled “Bond Duration: An Art, Not a Science.” In it, Jacobson listed the imperfections of duration as the predictor of how a given fund will behave when rates change. We wanted to follow up on that idea by doing an empirical study of how well fund durations predicted a portfolio’s actual behavior when bond yields change.
Concerns about rate hikes have acquired new relevance in recent months. Interest rates were already on the rise in the third quarter but that trend accelerated since Donald Trump was elected president: The yield on the 10-year Treasury note went up by 60 basis points in the weeks following the election and the Fed raised the target Fed funds rate at its December 14 meeting. Some bond managers and commentators opine that a bear market in bonds is coming, and investors are understandably concerned.