Ways to solve the current bond conundrum

By Clive Hale: Director, FundCalibre

Added 18th November 2016

Short duration or long duration? That is the question. And the answer, for past few years, has been 'long'. It's worked a treat for some. Could things be about to change or is the raging 30-year plus bull market going to go on for longer?

Ways to solve the current bond conundrum

While the Bank of Japan, European Central Bank and Bank of England are buying corporate bonds, there will be some artificial support, but that will have to be unwound at some point – March being a possible date when Draghi declares his hand.

In the US, it is still up in the air. It's been a year since the one and only rate rise since the global financial crisis began and if they don't make a move in December, the chances decrease substantially in the new year. Four members are due to rotate in January, with two hawks, one dove and one neutral being replaced with two doves, a hawk and a dovish neutral (if there is such a thing).

The bond world does seem to be smelling the coffee, however, with yields rising across all markets. The yields on 30-year bonds had a spectacular rise this month, hitting 3% in the US after the election result. They may pull back a little in the short term, but this could be a sign that the downward trend is finally reversing.

If yields continue to rise, losses will be mounting up for existing holders who have always considered bonds to be the safe haven. Long duration no longer seems the place to be.

Short duration

So where should bond holders turn now? The obvious answer would seem to be short duration. Short duration can be defined as anything with less than five years to maturity in the UK and less than three years in the US and Europe, where the bond markets have more depth and diversification.

A bond with lower maturity offers investors not only lower duration but also lower spread duration. In other words, these bonds exhibit a lower sensitivity to changes in government bond yields as well as credit spreads and can therefore be a useful tool in managing the risks of rising yields and market volatility.

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