Diverging durations leave corporate bond investors increasingly exposed
Are your investments more vulnerable to price loss if interest rates move higher? This week’s chart shows how durations have diverged on investment grade and high yield bonds.
January 25, 2020 | 1 minute read
Corporations have taken advantage of the ultra-low interest rate environment of the past decade, with many investment grade companies refinancing or issuing new, longer-dated bonds. Just since November 2018, for example, the average time to maturity on investment grade corporate debt rose by nearly a full year (from 10.6 to 11.5 years).1
Against this backdrop, the duration on the Bloomberg Barclays U.S. Corporate Bond Index, which measures investment grade bonds’ sensitivity to changes in interest rates, moved gradually higher through much of the past two decades and spiked in 2019.1
As the chart shows, the duration on high yield bonds has largely been a mirror image to that of investment grade debt, slowly declining the past 20 years and plummeting last year.1
In other words, traditional investment grade bonds – which many investors rely on as a source of income, stability and capital preservation – have become increasingly exposed to interest rate risk. High yield bonds, also a source of income for many investors, face less interest rate risk today than they did one year ago and far less than investment grade bonds.
Since the level of income traditional bonds provide has declined the past several decades, rising durations may leave investors increasingly vulnerable to price losses if rates move higher. While high yield bonds are subject to greater credit risk, they continue to be supported by an improving global economic outlook coupled with stable fundamentals, including low default rates and ample cash flows that allow high yield issuers to continue paying their debt service costs comfortably.
Private credit has increasingly become the preferred source of financing for PE sponsors, with direct lending volume jumping 60% over last year’s level.
