Duration is King! Long Live the King!

by Pat Luby

Poker-sm-232-KdThe total return king yesterday (Monday the 24th), was the Barclays U.S. Treasury: 20+ Year index, with a one day total return of 50 basis points. The loser, as you might expect, was Barclays U.S. Corporate High Yield which dropped 81 basis points on the day. (My observations are based on Barclays Index Returns, which are updated daily.)

After the violence in yesterday’s markets, some investors who had forgotten about (or drifted away from) the benefits of diversification may be thinking today about which bonds to add to counterbalance their equity allocation.

Do not be tempted to take on a new bond position based only on recent returns, but take a page from how professional portfolio managers make decisions. A professional manager is seeking to manage risk exposure—not to eliminate risks, but to mitigate some risks, while using other risks to seek incremental return. The manager’s investment process seeks to evaluate the potential reward associated with foreseeable risks—“buying” some (overweighting) and “selling” or hedging others (underweighting). Generally speaking, if they have money to put to work, they don’t look at the market and decide whether or not to invest today. Instead, they are more likely to ask, based on what the market is doing now and what they expect in the future, what is the best investment that they can make today?

For investors* seeking to diversify their portfolio, here are a couple of key points:

  • First and foremost, your portfolio should reflect your goals as defined by your investment plan or policy.
  • Do not chase returns. (In other words, duration may have been king yesterday, but not necessarily today or tomorrow.) Past performance is an important data point to consider, but not the only one.
  • It is impossible to know the future–hence, diversification is as important to investors as car insurance is to drivers.
  • Before you make any changes to your fixed income allocation, read about How to Time Interest Rates and to get a sense of the process used by full-time portfolio managers, the Benefits of Professional Management.

*These comments are relevant to investors–those with a longer-term investment horizon. Traders will have a much different perspective.

The information contained herein is based on sources believed to be reliable, but its accuracy is not guaranteed. The author does not provide investment, tax, legal or accounting advice. Investors should consult with their own advisor and fully understand their own situation when considering changes to their strategy, tactics or individual investments. Investments in bonds are subject to gains/losses based on the level of interest rates, market conditions and credit quality of the issuer. Additional information available upon request.

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