Premium

Welcome,Eric!

LogOut

CompanySite

Membership

Home

Portfolio

Stocks

Bonds

Funds

ETFs

CEFs

Markets

Tools

RealLifeFinance

Discuss

FundSpy

BondFundDuration:AnArt,NotaScience
Durationcanprovideguidance,butnotcertainty.
Print

Comment

Recommend(0)

Like 0

ByEricJacobson|110316|06:00AM|EmailArticle

The2008financialcrisisandtheresultingmarketshockshadanumberofsurprising
consequences.Onethatwasparticularlyimportanttobondinvestorswasthedegree
towhichdiversifiedbondfundsstruggledorlostmoney,eventhoughinvestorsthe
worldoverwerescramblingintoU.S.Treasuries.Takethelongtermgovernmentand
longtermbondMorningstarCategories.Mostofthetime,fundsinthesetwogroups
areexpectedtohaveprettysimilarriskstheybothfocusonbondswithlong
maturitiesandrelativelyhighqualitydebt.Yetthedivergenceintheir2008
performanceswasbreathtaking:Theaveragelongtermgovernmentfundgained
nearly28%,whiletheaverageportfoliointhelongtermbondcategoryfundsthat
holdmostlynongovernment,butinvestmentgradebondsfellbymorethan3.7%.
Why?

AbouttheAuthor
EricJacobsonisasenioranalystcovering
fixedincomestrategiesonMorningstars
managerresearchteam.

BumpingupAgainstthe
LimitationsofInterestRate
Duration
Undernormalcircumstances,
mosthighqualitybond
portfolios'effectivedurations
wouldhaveprovidedguidance
abouthowthosefundswould
respondtoTreasurymarket
shifts.Fundsinbothcategories
haveoccupiedawiderangeof
durationterritory,butnot
enoughtoexplainsuchabroad
dispersionofreturns.Andifthat
weren'toddenough,anearly
inversephenomenonoccurred
asthemarketsnappedback
fromthefinancialcrisisin2009.

Clearly,thisbehaviorwasnt
capturedbythecustomaryrisk
measureforTreasuryfunds.
Theprimaryreasonisthatdurationsomehavetakentocallingitinterestrate
durationworksbestforbondsthataresimilar.Durationwillnormallyprovidean
accuratepicturewhenyou'recomparingpricesonthesametypesofbonds.Inother
words,ifyou'reusingchangesinTreasurybondyieldsasyourreference,they're
goingtohavethemostpredictivevalueforotherTreasurybonds.Andundernormal
circumstances,atypicaldurationcalculationwillalsoworkprettywellforinvestment
gradecorporatebondswhoseyieldsaren'ttoofarawayfromtheircomparable
Treasurycounterparts,saywithin2percentagepoints.Onceyougetmuchfarther
awaythanthat,however,themeasurebeginstoloseitspredictivevalueasagauge
ofhowmuchmovementyourbondswillseerelativetoTreasuries.
ContactAuthor|Meetotherinvestingspecialists

IntroducingAdaptivePortfoliofromE*TRADECapital
Management

MostActiveStocks

Ticker

Price($) Change(%)

BAC

19.78

1.93

WFT

5.28

2.62

SINO
RF

6.11

147.37

13.06

3.47

CHK
FB

5.98

1.16

117.33

0.12

SIRI
AAPL

4.56

0.44

109.52

2.25

7.23

1.09

16.68

2.4

VALE
KEY

Morningstar
Rating

Morningstar
AnalystReport

WithMorningstarAnalystreportsyoucangetourexpert
Buy/Sellopinionsonover3,900StockandFunds

VideoReports

IsGoodTimingtheKeyto...
MoreVideos...

Fortunately,wecanestimatethatkindofriskwitharelatedmeasurecalledspread
duration.
SpreadDurationAddingtotheToolkit
Insteadofestimatinghowmuchabondwillgainorlosebasedonchangesin
Treasuryyields,spreaddurationdescribeshowmuchabond'spriceisexpectedto
moveifthere'sachangeinthegapbetweenitsyieldandthatofacomparable
Treasury.Ifyouwerelookingatacorporatebondwithfiveyearsofspreadduration,
forexample,thatmightnotseemespeciallylonggivenhowwetendtoviewstandard
effective(orinterestrate)durationfigures.Ifthecompanyhitaparticularlyrough
patchduringotherwisenormaltimesanditsyieldspreadoverTreasurieswidenedby
300basispoints(or3%),thebondwouldbeexpectedtolose15%.Spreadsonthe
overallBloombergBarclaysCapitalInvestmentGradeCorporateBondIndexwidened
tomorethan640basispointsinDecember2008,though,fromaroundonly100in
February2007.Assumethatkindofspreadwideningthatis,intheneighborhoodof
550basispointsandthebondwouldhavelostnearlytwicethat.
UseWithCare
Regardlessofwhatyou'remeasuring,though,it'simportanttobemindfulthat
duration,likealmostanyothermeasure,comeswithimportantcaveats.
1.Durationisanestimate.It'sdesignedtohelpyougaugehowmuchabond's
priceislikelytoriseorfallgivenasuddenchangeinmarketyields.Evenunder
relatively"normal"conditions,though,abond'spricemaynotmoveexactlyasits
durationpredicts.
2.Portfoliodurationsarejustaverage.Thedurationofafundportfolioconsists
oftheweightedaverageofthedurationsofitsunderlyingbonds.Thosebondsusually
haveverydifferentweightsandmaturities,sothegainorlosspredictedbyduration
wouldbemostaccurateifmarketyieldschangebyexactlythesameamountfor
everybondalongthematurityspectrum.Suchasituationisrare,though.Infactit's
possibleforsomeratestorisewhileothersfall(ayieldcurvetwist).Inthatscenario,
twodifferentfundswiththesameaveragedurationcouldperformverydifferently.
3.Evensecuritieswiththesamedurationscanperformdifferentlyfromone
another.Wevealreadyseenthatinthecorporatebondexampleabove.Butthere
arefactorsthatcanaffectotherbondstoo,especiallythosewithembeddedoptions,
suchasgovernmentagencymortgages.Themorecomplexabondsstructure,in
particularthepresenceofveryflexibletermssuchasthosegivingahomeownerthe
optiontorefinanceatanytime,themoreestimationandmodelingisinvolvedin
arrivingatadurationmetric.Insuchcases,itsquitepossiblethattwoasset
managerswouldassigndifferentdurationestimatesfortheverysamemortgage
bond.Fortunately,wedontusuallyseemassivedispersionacrossportfoliosasa
resultofthatphenomenon,butitsimportanttounderstandthatthereareusually
modelingassumptionsandnotjuststrictformulasbehinddurationcalculations.
4.Readthefineprint.Tounderstandyourbondfundbetter,digintoitsmost
recentportfolioreportandtrytofigureoutwhatitholds(oraskyourfinancial
advisortodoitforyou).Ifyoufindthingsthatyoudon'trecognize,suchinterest
onlymortgageCMOsorinverseIOs,forexample,lookforaclearexplanationinyour
fund'sreportsabouthowandwhythefundisusingthem,orpickupthephoneand
callyourfundcompany.Weseethempopupinsmallamountsfromtimetotime.
Butgivenhowvolatilethosecomplexsecuritiescanbeifshorttermratesand/or
prepaymentsshiftnotably,you'llwanttomakesureyou'recomfortablewithyour
fundsreasoningandriskcontrols,especiallyiftheyappearinconcentrationsofmore
thanafewpercentagepoints.
Inshort,durationorinterestratedurationcanbeausefulindicatorforestimating
theinterestrateriskofbondsthatcloselytracktheTreasurymarket.Anytimeyou
deviatefromowningTreasuries,youusuallygetpaidmoreyieldandperhapsgeta
betterlongertermtotalreturn(perhaps).Butyouassumemoreanddifferentrisks,
andtrackingthemallbecomesmorecomplicated.Itthereforemakessensetouse
durationwithsomecautionandtomaketheefforttoknowwhat'sinafund's
portfolio,ratherthanrelyingondurationoranyothersinglenumberorgradewhen
evaluatingitssuitabilityforyourportfolio.
AversionofthiscolumnwaspublishedinApril2013.

Comments

OldestFirst|NewestFirst

MostPopular
10GreatBalancedFunds
HighQualityDividendsforaSlimFee
VanguardDividendGrowth'sClosureSparksChangeinBucket
Portfolios
NavigatingaLowYieldEnvironmentinRetirement
GoingDefensive?LookatThese3Funds
Clickheretoviewall
RelatedNews
AlsoinFundSpy

SponsoredLinks

SponsorCenter

18of8Comments

DG99999
Nov32016,9:12AM
Flag
Like 0

"...Yetthedivergenceintheir2008performanceswas
breathtaking:Theaveragelongtermgovernmentfundgained
nearly28%,whiletheaverageportfoliointhelongtermbond
categoryfundsthatholdmostlynongovernment,butinvestment
gradebondsfellbymorethan3.7%.Why?"
ThisillustrateswhysomearecontentwithTreasuriesasbond
holdingsthoughitiscertainlynotapopularview.VFITXisprobably
morepalatableandstillreturnedover13%in2008.Ofcoursethe
governmentheavyindexwaspositivetoo(about5%),itjustdid
notgivequitethesamediversificationimpactduringthisextreme
event.

Nittwit
Nov32016,9:38AM
Flag
Like 0

compufixer
Nov32016,1:28PM
Flag

ThancametheFederalReservewithitsQEforeverandlowerfor
longerattitude.ForsomeoneclosetoretirementtherisksofBond
fundsofmediumtolongtermdurationhasgoneup.Thismakes
theirvalueinyourportfoliohardertojudge.Thetypical60/40will
probablylose,Ikeepminedownto80/20andholdmorecash.It
worksformebecauseofthesizeanddiversificationofmyportfolio
versuswhatIexpecttoneedtoliveoninretirement.Itsnota
sciencebutanartthatusesalgebraandgraphs.
Mr.Jacobsen,
DoesM*givedurationsfortheBondETFsitlists?Ilookedandwas
unabletofindit,foracoupleofdifferentETFs.Icertainlyagreeit's
relevantinformationbeforepurchasing,duediligence&allthat.

Like 0

skipperchg
Nov32016,3:25PM
Flag
Like 0

Nittwit,"ForsomeoneclosetoretirementtherisksofBondfundsof
mediumtolongtermdurationhasgoneup.Thismakestheirvalue
inyourportfoliohardertojudge."
Couldyousaythatthedurationriskhasremainedthesame,but
yourcapacitytobeartheriskhasgonedown?Aretiree(or
someoneclosetoretirement)maynothave10yearsormoretolet
abondfundrecovertoitsoriginalvalue.
Perhapslookatashorterdurationwiththesametypeofbond
diversificationthelongerdurationfundsprovide.TryFidelity
IntermediateBondFund(FTHRX)Fund,SECyield1.82%,duration
4,creditqualityA,down5.84%in2008butup17.17%in2009,or
similarfunds.Ormaybeasimilardurationnationalmunifund.Our
retireeshavebeenhappywiththeriskprofile.Theywouldlikemore
yield,butyoucannothaveeverything.VFITXhasfartomuchrisk
forourpopulation.

Holiday
Nov32016,10:48PM
Flag
Like 0

"...Yetthedivergenceintheir2008performanceswas
breathtaking:Theaveragelongtermgovernmentfundgained
nearly28%,whiletheaverageportfoliointhelongtermbond
categoryfundsthatholdmostlynongovernment,butinvestment
gradebondsfellbymorethan3.7%.Why?"
Thefinancialcrisisof2008wasnottheresultoftheFederal
Reserveraisingtheovernightrate.Thefinancialcrisisof2008was
aliquiditycrisis,anddurationdoesnotmeasuresensitivitytothose.
Duringafinancialcrisis,thepriceofLongTreasuryBondsare
negativelycorrelatedtothepriceofstocksandmostcorporate
bonds.Somecallthisthe"flighttosafety".Theresultin2008was
thatstockslost~50%andLTTreasuryBondsgained28%.
An"investmentgradeportfolio"ofcorporatebondswillgenerallybe
BBBorhigher.ThisisnottheequivalentofaportfolioofUS
TreasuryBondseventhoughbothportfoliosareconsidered
"investmentgrade".
Thefederalreserveusuallyentersacycleofincreasingthefederal
fundsratebecauseitthinkstheeconomyisoverheatinginflationis

tickingupbeyondthetargetedlevel.In2008,theconcernwas
deflationandnotinflation.
Anoverheatingeconomyisprettymuchthepolaroppositeofa
liquiditycrisis.Thefederalreservedidnotraisethefederalfunds
rateinresponse.TheresponsewasQEwhichistheoppositeof
increasingovernightrates.
JMO,
Holiday
xejir
Nov42016,8:22AM
Flag
Like 0

Ona10yrchart....TGLMXoutperformsbothVFITXandespecially
FTHRX.EvenOSTIXdoesbetterbutwithmorerisk.PIMIXdoes
verywell...somerisk.Lookforbestsharpe?
Itsnotjustwhathappenedin08....it'swhathappensafterwards.
Downsideriskisanissue...underperformanceisalso.
Lookatwhathappenedin2013?MERFXandOSTIXheldup.
I'dconsideranybondfundthathadnomoredownsidein08than
M*sIntTermBondindextobeviable.

M*_EricJ
Nov42016,3:45PM
Flag
Like 0

Hicompufixer
WedopublishdurationdataforETFs.Youcanfinditinatleasttwo
placesonmorningstar.com,includingonthemain"Quote"tab(on
therightsideinthesectionlabeled"StyleMap"),andunderthe
"BondStatistics"sectiononthe"Portfolio"tab.
Morningstarsurvey'seachfundcompanyfordurationdata,but
someunfortunatelyleaveholesinwhattheysendtous.Ifyouare
lookingatafundthatlacksdataintheAverageEffectiveDuration
field,that'sthemostlikelyexplanation.
Ihopethat'shelpful.
Regards,
EricJacobson
Morningstar

M*_EricJ
Nov42016,4:02PM
Flag
Like 0

HiHoliday
Iavoidedgoingintotheunderlyingreasonsforwhathappenedin
2008forpurposesofkeepingthepiecefocused,butyou'llnotethat
Ididn'tactuallyascribethefinancialcrisistoactionsonthepartof
theFed.(Infact,I'minthecampthatstronglybelieveswewould
haveplummetedintoadeepdepressionwithoutextraordinary
measuresonthepartofboththeFedandtheU.S.Congress.)
Thatsaid,whatyou'vewrittenisnotjustyouropinionbutrathera
veryaccuratedescriptionofthefacts.Thearchiveforourcolumns
onmorningstar.comunfortunatelydoesn'tgobackfarenoughfor
metofindthelinks,butI/wehavespilledalotofinkdrawing
attentiontotheexactpointsyoumake,goingbackallthewayto
thetimeofthecrisisitself.
Regards,
EricJacobson
Morningstar

AddaComment

OldestFirst|NewestFirst

18of8Comments

Post

Emailmenewreplies.

ContentPartners

SiteDirectory
Corrections

Help

SiteMap

AdvertisingOpportunities

OurProducts
LicensingOpportunities

Glossary

RSS

MobilePortfolio

Affiliate

Careers

CompanyNews

InternationalSites: Australia Canada China France Germany HongKong Italy TheNetherlands Norway Spain U.K. Switzerland India Finland
Stocksby: Name | Ticker | StarRating | MarketCap | StockType | Sector | Industry
MutualFundsby: StarRating | InvestmentStyle | TotalAssets | Category | TopHoldings | TopSectors | Symbol/Ticker | Name
ETFsby: StarRating | Category | TotalAssets | Symbol/Ticker | Name Articlesby: Title | Date | Author | Collection | Interest | Popularity
InvestmentCategoriesby: Topic | Sector | KeyIndicators | UserInterest | MarketCap | Industry
PremiumStocksby: Name | Ticker | StarRating | MarketCap | StockType | Sector | Industry
PremiumMutualFundsby: StarRating | InvestmentStyle | TotalAssets | Category | TopHoldings | TopSectors | Symbol/Ticker | Name
PremiumETFsby: StarRating | Category | TotalAssets | Symbol/Ticker | Name PopularArticlesby: Title | Date | Author | Collection | Interest | Popularity
PopularInvestmentCategoriesby: Topic | Sector | KeyIndicators | UserInterest | MarketCap | Industry
Independent.Insightful.Trusted.Morningstarprovidesstockmarketanalysisequity,mutualfund,andETFresearch,ratings,andpicksportfoliotoolsandoption,hedgefund,
IRA,401k,and529planresearch.Ourreliabledataandanalysiscanhelpbothexperiencedenthusiastsandnewcomers.
Copyright2016Morningstar,Inc.Allrightsreserved.Pleasereadour TermsofUse and PrivacyPolicy. DowJonesIndustrialAverage,S&P500,Nasdaq,andMorningstar
Index(MarketBarometer)quotesarerealtime.