How to Diversify Assets Like a Pro When You Own a Lot of Equities
Long duration is the "Sharpe" choice for aggressively positioned portfolios.
The yield on the 30-year U.S. Treasury fell below 2% for the first time ever on Aug. 15 and has changed little since. That marked an incredible rally in those long-term bonds, which were yielding nearly 3.50% on Nov. 2, 2018. Vanguard Long-Term Treasury ETF (VGLT), which mainly holds U.S. government bonds with maturities between 20 and 30 years, rallied 31.9% over that time period, nearly triple the return of Vanguard Total Bond Market ETF (BND), which gained 11.9%. Clearly, long duration has been as hot as the new Taylor Swift album this year, which may seem like a poor time to consider it for a portfolio. For investors with big equity allocations, however, long duration is one of the best diversifiers for a portfolio.
A Quick Refresher on Duration
Duration is a measure of a fund’s sensitivity to interest rates. In simple terms, the higher a fund’s duration, the more sensitive it will be to moves in interest rates. For example, a bond fund with a duration of five years would be expected to gain (lose) 5% of principal for a 1% parallel fall (rise) in interest rates across the yield curve. Things can get a bit more complicated depending on exactly where on the yield curve the fund is most concentrated, as Morningstar fixed-income super sleuth Miriam Sjoblom points out in this article, but the general idea holds that higher duration equals more interest-rate sensitivity.
Megan Pacholok does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.