Duration Is Not Defensive

WHAT THE GLOBAL FINANCIAL CRISIS CAN TELL US ABOUT FIXED INCOME

Above is a chart tracking the performance of various fixed income indices before, during, and after the Global Financial Crisis in 2008. Before I continue, I want to clarify that we do not expect another financial crisis in the near future.

However, we have recently adopted a defensive stance as we see a growth slowdown in the United States in the near future and asset valuations are at the upper end of their historical range. As such, it is a worthwhile exercise to study the last recession as it provides a good case study (albeit extreme) on which fixed-income subsectors tend to do well in a difficult macro-economic environment. As illustrated in the chart, the Bloomberg Barclays US Long Treasury Total Return Index (dark blue) performed the best during the most acute sell-off of the Financial Crisis. From November 2008 until the beginning of 2009, the Index returned approximately 24%. Meanwhile, High Yield (light red) investors experienced a 33% loss by 2009 had they invested at the beginning of 2007. Even investment grade corporates with longer duration took a hit, despite longer-term yields moving lower. The Bloomberg Barclays U.S. Long Credit Index (beige) was down over 20% in the Fall of 2018. Notably, the Bloomberg Barclays 1-5 Govt/Credit Total Return Index (light blue) was relatively resilient. It did experience a 2.4% drawdown in the second quarter of 2008, but nothing on the magnitude of the other longer duration credit indices. 

The 2008 case study is an extreme one, however, it illustrates the double-edged sword that duration can be. Duration is a measure of the sensitivity of a bond relative to the change in its underlying yield. The longer the duration, the more risk, both upside, and downside. In the case of treasuries in 2008, duration helped its return profile. However, in the case of investment grade corporate bonds, duration had the opposite effect. Credit indices also fail to take into account for credit downgrades since there is survivorship bias. As such, longer duration holdings may have experienced sharper drawdowns.

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Disclosure: This article is distributed for informational purposes only and should not be considered investment advice or a recommendation of any particular security, strategy or investment product. ...

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