Do you know the (duration) risk you're taking?

Stephen Groff's picture

With the recent interest rate volatility, it could be timely to revisit the idea of duration and the risks that exist in what are perceived to be "safe" investments. Below is a chart provided by Bank of America Merrill Lynch. While there is no magic here, the math is powerful and insightful.

 

 

The "breakeven yield increase" column is key as it shows the amount interest rates would need to rise for the capital loss to wipe out an entire year's worth of interest payments. Given that short-term government securities yield almost nothing, it's no surprise to see investors reach for higher yields while accepting 1) longer duration and 2) lower quality. While this chart only captures the impact of duration, many investors may be underappreciating the risk to their portfolio from even a minor increase in rates.

As a frame of reference, the U.S. 10-year yield has increased over 40 basis points in the last three trading days. This wipes out considerable return in what is perceived by many to be risk free.

Just some food for thought.

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