Empirical duration is negative in below-investment-grade asset classes
Source: ICE BofAML U.S. Corporate Index, ICE BofAML U.S. High Yield Index, S&P/LSTA Leveraged Loan Index. Based on rolling 10-year data ended October 2020. Duration measures the sensitivity of a bond’s price to changes in interest rates. Empirical duration uses historical data to calculate the observed change in a bond‘s price given changes in rates. It is calculated regressing weekly change in high yield bond index prices and weekly change in 5-year U.S. Treasury yields.
- The first trading week of 2021 largely picked up where 2020 left off. Stocks set aside significant political unrest in the U.S. and continued to move higher while returns on traditional bonds remained challenged amid rising Treasury yields.
- The pace of the 10-year U.S. Treasury yield’s rise, which was gradual through much of 2H 2020, accelerated this week amid expectations that a Democratic-controlled federal government will provide additional fiscal stimulus measures, boosting economic growth and inflation.
- With 10-year yields at their highest level since March, duration, which measures the sensitivity of a bond’s price to changes in interest rates, has once again come into focus for many investors.
- The chart compares traditional, or stated, duration to empirical, or observed, duration across fixed income asset classes over the past decade. (Empirical duration uses historical data to calculate the observed change in a bond‘s price given changes in rates.)
- While high yield bonds and senior secured loans naturally feature lower duration profiles than investment grade corporate bonds, the empirical duration figures tell a more complete story of their relationship to interest rates. In fact, over the past decade, prices on high yield bonds and senior secured loans have increased 1.5% and 2.5%, respectively, for every 100 basis points interest rates have increased.1
- In an environment in which many investors may be looking to reduce or diversify their interest rate risk, below-investment-grade bonds may be particularly attractive as they are generally more reactive to company-specific fundamentals and macroeconomic conditions than interest rates.