The sensitivity of a Central Bank’s monetary decision, primarily in terms of rate hikes, has a huge impact on a portfolio’s performance, both on the upside and on the downside. Not getting much into the technical detail, a portfolios modified duration indicates the portfolio’s sensitivity to a move in interest rates. A practical example- given that a portfolio has a modified duration of 3, technically speaking, a 1 percent rate hike should impact negatively the portfolio by 3 percent. The reversal is also implied. As a reminder, modified duration follows the concept that interest rates and bond prices move in opposite directions.
The current market environment
In the second half of 2018, expectation of rate hikes increased and this is one of the reasons, apart from the geopolitical tensions, we saw credit markets experiencing the first negative year in decades. Thus, in line with the technical principle, portfolio managers which had a high portfolio duration, were experiencing a higher negative movement to other which a held a lower duration.
Indeed, the persistence of the Federal Reserve (Fed), to increase rates in December, has exuberated the movement in yields with U.S. investment grade bonds being the prime losers within the credit space, followed by the more risky assets. In fact, in December we were seeing very high quality credit names being harshly hit as expectations of a hike increased.
Today, we are seeing a reversal following the change in stance by the leading Central Banks. In fact, following the announcement by the Fed of a more dovish stance in terms of hikes, we experienced a notable re-pricing in credit markets. Indeed, on a year-to-date basis U.S. IG credit is close to 3 percent, while U.S. HY is up 6 percent.
In line with the duration concept, the recent change in monetary stance that of being more accommodative, has led to the relatively good performance on a year-to-date basis. Moreover, those investors who had the vision to increase their portfolio duration are benefitting from higher returns, compared to those, which held a low modified duration. Let’s not forget that the markets move on expectations and thus the probability of no rate hikes have triggered the recent positive moves.
Moving forward, growth figures have been revised downwards globally. In this regard, the more patient stance by monetary politicians, gives credit investors lean-way to increase their portfolio durations. Indeed this is what we have been doing over the past days, increasing our portfolio duration in order to capture the implied the higher return. We believe, that in the short-to-medium term we should see a prolonged accommodative stance and thus this gives credit investors the opportunity to lock higher returns by taking longer term risks-not specific credit risk, but maturity risk in this case.
The Calamatta Cuschieri Traders Blog is available daily on CC WebTrader. Other market coverage including coverage of the International Bond Markets is also available.
The information provided on this website is being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice. Similarly any views or opinions expressed on this website are not intended and should not be construed as being investment, tax or legal advice or recommendations. Investment advice should always be based on the particular circumstances of the person to whom it is directed, which circumstances have not been taken into consideration by the persons expressing the views or opinions appearing on this website. Calamatta Cuschieri & Co. Ltd. (CC) has not verified and consequently neither warrants the accuracy nor the veracity of any information, views or opinions appearing on this website. You should always take professional investment advice in connection with, or independently research and verify, any information that you find or views or opinions which you read on our website and wish to rely upon, whether for the purpose of making an investment decision or otherwise. CC does not accept liability for losses suffered by persons as a result of information, views or opinions appearing on this website.
This website is owned and operated by Calamatta Cuschieri & Co. Ltd (Co. Reg. No. C13729) of 5th Floor, Valletta Buildings, South Street, Valletta VLT 1103, Malta. CC is licensed to conduct Investment Services in Malta by the Malta Financial Services Authority.