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Global bonds' near record high duration becomes a big risk

Kitco News

Jan 13 (Reuters) - Global bond portfolios are more sensitive than ever now, given their extended maturities increase the risk of capital losses as the Fed and other major central banks prepare to aggressively tighten policy.

The FTSE World Government Bond Index (.SBWGU), which comprises sovereign debt from over 20 countries, has an average duration of 8.75 years, according to Refinitiv Eikon data. That compares with a duration of 7.8 years in 2018 and 6.6 years around the 2013 'taper tantrum'.

The duration of a bond portfolio is the weighted average time of all the payments an investor receives, and a measure of how a bond's price responds to changes in interest rates. A bond with a duration of 10 years will see its price fall roughly 10% if rates rise by a percentage point.

Duration has risen as companies and governments around the world borrowed through longer term bonds heavily in the past few years to take advantage of ultra-low interest rates.

The FTSE World Broad Investment-Grade Bond Index's (WorldBIG) (.SBAHCPC) duration is at 7.5 years, near a 2020 record high.

Duration of world bond indexes
Duration of world bond indexes

"Duration, or sensitivity to changes in interest rates, is near all-time highs for many fixed-income asset classes, leaving them vulnerable to total return losses on even modest moves," said Winnie Cisar, global head of strategy at research firm CreditSights, based in North Carolina.

Duration of global bonds
Duration of global bonds

Benchmark U.S. 10-year Treasury yields are at their highest levels in almost two years as investors prime for the Federal Reserve to begin rising rates as soon as March, while it also shrinks its balance-sheet and sucks cash out. Investors are bracing for the Fed to raise rates four times this year.

That "will have a profound negative impact on returns for higher-duration bonds and thus makes them much riskier," said Patrick Wood, chief executive officer at financial services firm DelphX.

Investors have been dumping U.S. investment-grade bonds over the past month as their lower coupons and longer maturities make them more vulnerable to duration risks.

BlackRock’s iShares iBoxx Investment Grade Corporate Bond ETF fell to a 9-1/2 month low of $129.03 this week.

According to Refinitiv data, U.S. investment-grade bonds faced outflows of $16.2 billion in December, the biggest since March 2020.

"We are cautious on duration risk, so we expect debt markets that have low yields/long maturities, like US IG to post total return losses," said Cisar.

Monthly fund flows: US investment grade and high yield
Monthly fund flows: US investment grade and high yield

Andy Kapyrin, director of research at RegentAtlantic Capital, recommends investors buy inflation-protected bonds, floating-rate bank loans and alternative investments with bond-like risk-return profiles in the current scenario.

"The most vulnerable parts of the bond market are long-term bonds issued by the treasury, investment grade corporations, and municipalities. They have too little cushion to protect investors if yields rise."

Additional Reporting by Gaurav Dogra in Bengaluru Editing by Vidya Ranganathan and Nick Zieminski
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