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How to overcome the short-duration hype

How to overcome the short-duration hype

Investors in the fixed income space are often plagued by the duration debate. Short duration is a hot topic and big fund houses, such as AXA IM, Jupiter, and Candriam, have all launched strategies focused on this area in recent months.

With attention increasing, what does the race for a foothold here mean for fund buyers? In this edition of Selector Snapshot, an investment professional debates whether or not you should be positioned in the long end part of the curve.

Selector: Jean-Baptiste Fargeau

Company: Banque de Luxembourg Investments

The current interest rate environment makes it difficult to generate attractive returns. To achieve a decent return, it is possible to increase the risk by investing in lower quality bonds, or by increasing the duration of your portfolio.

Many asset management companies today propose short duration high yield strategies. For these funds, the problem remains the same as these portfolios have low returns. However, investors feel comfortable with those kind of funds thanks to the low volatility, while on both sides of the Atlantic, central banks are keen to normalise their monetary policies.

Short duration strategies are less volatile and will protect the portfolio in the event of rate hikes. Nevertheless, their recovery period is often longer than that of a ‘normal’ duration strategy.

Positioning in high yield gives a decent yield in a low-interest rate environment. However, in times of uncertainty, spreads rise quickly and default rates too, as we experienced in 2015/2016.

Today, the spread between the US 2-years and 10-years is close to 50 basis points, such a low spread has regularly led to a reversal of the US yield curve and to a recession, in the medium term. This compression of the 2-10 year spread is the result of the two-year rate increase, with the 10 year remaining stable, which is a typical end-of-cycle situation.

In this environment, would it not be interesting to favour longer-maturity assets with excellent credit quality? From this point of view, taking a position on the US 10-year could be considered a good opportunity.

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