Speaker 1: Bloomberg Audio Studios, podcasts, radio news.
Speaker 2: How should investors manage bond duration in an era of
Speaker 2: rising and likely soon falling interest rates? The challenge. Long
Speaker 2: duration bonds lose value when rates go up. Shorter duration
Speaker 2: bonds can also lose value, but far less. What happens
Speaker 2: when the reverse occurs when rates falls, well, the value
Speaker 2: of long duration bonds go up, shorter duration go up
Speaker 2: but less. As it turns out, there are many ways
Speaker 2: investors can take advantage of changing interest rates. I'm Barry
Speaker 2: Redtolts and on today's edition of At the Money, we're
Speaker 2: going to discuss how to manage your fixed income duration
Speaker 2: when the Federal Reserve becomes active when it comes to
Speaker 2: interest rates. To help us unpack all of this and
Speaker 2: what it means for your portfolio, let's bring in Karen Vera.
Speaker 2: She is head of I Shares US fixed Income strategy
Speaker 2: for Investing Giant Blackrock. So Karen, let's just start with
Speaker 2: the basics. What is duration, why does it matter? And
Speaker 2: why does it seem so confusing to so many bond investors.
Speaker 3: So duration is simply the interest rate risk of a bond,
Speaker 3: or you can think about it, it's the amount that
Speaker 3: the price is going to change in response to a
Speaker 3: change in interest rates. So the nice thing is today
Speaker 3: almost any bond or bond fund will typically have that
Speaker 3: duration number published. So if the duration for examples five,
Speaker 3: if interest rates go up by one percent, that bond
Speaker 3: will drop in value by five percent. So it's a
Speaker 3: pretty easy relationship to think about. I think where it
Speaker 3: gets tricky is that that's just an average for the
Speaker 3: bond or for the bond portfolio. But there's also durations
Speaker 3: or the interest rate risk at different points on the
Speaker 3: yield curve, So like two year, we call those key
Speaker 3: rate durations, so you can think of how much am
Speaker 3: I exposed to two year point, the five year point,
Speaker 3: ten year point, twenty and thirty. And then we also
Speaker 3: have something called credit spread duration. How much does the
Speaker 3: bond's price change in response to changes in credit spread
Speaker 3: or the additional yield over treasuries. So I think when
Speaker 3: investors think through interest rate risk and how much risk
Speaker 3: they want to take, duration is a helpful measure for
Speaker 3: at least quantifying the loss that they could have from
Speaker 3: changes in rates.
Speaker 2: So let's look at some real life examples. The FED
Speaker 2: began raising rates in March twenty twenty two. About eighteen
Speaker 2: months later, they pretty much finished and we were over
Speaker 2: five hundred points basis points higher then we began. How
Speaker 2: did that impact bonds, both short and long duration?
Speaker 3: We actually had an in two, one of the worst
Speaker 3: years in terms of bond performance in decades. The AG
Speaker 3: or the aggregate index, which is the broad measure of
Speaker 3: the tax wile bond market, was down about thirteen percent,
Speaker 3: and that has an intermediate duration, our duration of between
Speaker 3: five and six years. However, long bonds had double digit losses.
Speaker 3: I think twenty plus year treasuries were down over twenty percent,
Speaker 3: and I think that was really hurtful for a lot
Speaker 3: of investors who had moved into bonds just coming off
Speaker 3: of the zero interest rate policy that the FED adopted
Speaker 3: after COVID.
Speaker 2: And if memory serves me, I think twenty twenty two
Speaker 2: was the first year since like nineteen eighty one where
Speaker 2: both stocks and bonds were down double digit very unusual,
Speaker 2: you know, twice a century sort of thing.
Speaker 3: That's right, and it really comes back to, you know,
Speaker 3: why we're interest rates going up, why it's stocks under
Speaker 3: perform it, And it goes back to the inflationary environment
Speaker 3: post COVID inflation came back into the system and the
Speaker 3: Fed needed to do needed to tighten interest rates in
Speaker 3: order to stop inflation and get the economy back on track.
Speaker 3: And so you know, we had investors reacting to that,
Speaker 3: and that's why we saw a year where both asset
Speaker 3: classes were down.
Speaker 2: So prior to the initiation of that rate hiking cycle
Speaker 2: in twenty twenty two, it felt like, at least for
Speaker 2: most of my adult life, going back to Paul Volker
Speaker 2: as Chairman of the FED in the early eighties, interest
Speaker 2: rates pretty much did nothing but go down. It felt like, hey,
Speaker 2: for forty years we had nothing but on average lower rates.
Speaker 2: Is that an exaggeration or is that pretty much what
Speaker 2: took place?
Speaker 3: No barrier spot on we did. We have seen interest
Speaker 3: rates fall, and I think it's for a few different reasons.
Speaker 3: I think the central bank got better at managing inflation,
Speaker 3: so if inflation is lower than the absolute level of
Speaker 3: rates are lower. We saw globalization where things became cheaper,
Speaker 3: more efficient, And we also have an aging population. In
Speaker 3: various studies we've seen that as economies age, interest rates
Speaker 3: tend to be lower, biggest consumption behavior changes. So we
Speaker 3: had all of those tailwinds kind of pulling interest rates
Speaker 3: down over the years.
Speaker 2: So about forty years, as far as you know, is
Speaker 2: that the longest bond bull market in history, or at
Speaker 2: least in US history. I don't know what happened in
Speaker 2: Japan a thousand years ago, but.
Speaker 3: Yeah, I think in modern we could say modern history.
Speaker 3: I think that is a fair statement, right.
Speaker 2: And probably unlikely to ever be matched again in our
Speaker 2: lifetime or perhaps our kids and grandkids. So let's talk
Speaker 2: about what started a couple of years ago. The yield
Speaker 2: curve inverted. How does that impact bond investors? If you're
Speaker 2: getting paid the same for long duration as you are
Speaker 2: for short duration, why would you want to hold long
Speaker 2: duration paper?
Speaker 3: Yeah, we've seen these inverted yield curves. They typically happen
Speaker 3: before recessions, and they typically happen when the market expects
Speaker 3: short term rates to come down following a period of
Speaker 3: rates being risen higher. So we're at the point where
Speaker 3: the yield curve is still inverted, and the response has
Speaker 3: been pretty amazing by investors. They've all moved into ultrashort
Speaker 3: duration bonds, money market funds, bank deposits, or at all
Speaker 3: time highs. In fact, even in August with a lot
Speaker 3: of the market volatility. We just observed we saw very
Speaker 3: strong flows coming into money market funds, so people are
Speaker 3: literally sitting in cash. And then we have some data
Speaker 3: on the average financial advisor's portfolio is about seven percent
Speaker 3: in cash or ultra short term bonds, which is down
Speaker 3: from over ten to fifteen percent, So now they're sitting
Speaker 3: at seven. So we're still seeing a lot of even
Speaker 3: professional investors are keeping their keeping things in cash in
Speaker 3: response to this inverted yield curve.
Speaker 2: So let's take a closer look at that. For a
Speaker 2: long time, investors or cash holders were getting practically nothing
Speaker 2: for a decade or so, but after the FED brought
Speaker 2: rates up to five and a quarter, you could get
Speaker 2: five percent and change in a fairly risk free money market.
Speaker 2: What sort of competition does that create for longer duration
Speaker 2: bonds and our money markets truly considered liquid cash, how
Speaker 2: do you categorize them?
Speaker 3: I'll take the money market fund question first, So we
Speaker 3: do see money market funds are considered cash equivalents. You
Speaker 3: can typically get your money back within a day, just
Speaker 3: depending on the cutoff cycle with your with the provider.
Speaker 3: So we see a lot of people sitting in those
Speaker 3: cash and ultra short term investments because they are liquid
Speaker 3: and they are yielding a lot. However, we're seeing more
Speaker 3: people wanting to add some duration. So if I can
Speaker 3: get five percent today, that's great. But if the Fed
Speaker 3: starts cutting in September December really moves that overnight rate
Speaker 3: back down into that three percent range, which is what
Speaker 3: we think it will do over the long term, those
Speaker 3: five percent yields are going to disappear on you. So
Speaker 3: we are seeing investors building bond ladders, adding intermediate duration
Speaker 3: because when that yield curve does start to reshape more, normally,
Speaker 3: where you get the most bang for your buck is
Speaker 3: in the belly of the curve, that three to seven
Speaker 3: year maturity. So not only can you lock in four
Speaker 3: or five percent yields there, but then you can get
Speaker 3: some price appreciation when interest rates begin to come down.
Speaker 3: So that's really what we're seeing investors doing right now
Speaker 3: is moving out the curve a bit in response to
Speaker 3: the following rate environment that's coming.
Speaker 2: So I'm glad you brought that up. We're recording this
Speaker 2: right after the Labor Day holiday weekend in twenty twenty four.
Speaker 2: Everybody has pretty much agreed Drome Palace come out and
Speaker 2: said it, Hey, we're going to begin cutting rates. The
Speaker 2: long wait is over. And you mentioned fifteen was it?
Speaker 2: Fifteen trillion went down to seven trillion in money markets?
Speaker 2: Is the assumption that a lot of this is flowing
Speaker 2: into intermediate or longer dated bonds in anticipation of the
Speaker 2: FED cutting word is going on. With all that cash
Speaker 2: moving around.
Speaker 3: We absolutely have seen a lot of people are still
Speaker 3: staying put. So we don't see people moving until they
Speaker 3: need to, until they actually see the rates drop on
Speaker 3: some of their money fund money market funds. But we
Speaker 3: are seeing some money coming into BONDI tfs, both index
Speaker 3: funds and active funds. We're seeing more people building out
Speaker 3: bond ladders so through term mature to ETFs such as
Speaker 3: our ivonds, So we are seeing some of the money move.
Speaker 3: We're actually looking up north to Canada. Canada has gone
Speaker 3: through a few rate cuts now and we're seeing money
Speaker 3: in that market move back into bonds quicker than in
Speaker 3: the US on a percentage basis. So I think, well,
Speaker 3: we will see a lot of money move this fall
Speaker 3: and into twenty twenty five. I think when people actually
Speaker 3: notice that the rates are coming down in some of
Speaker 3: these cash like products.
Speaker 2: So pardon my niavite for asking such an obvious question.
Speaker 2: If you wait for rates to fall to move into
Speaker 2: longer duration bonds, haven't you missed it? I mean, don't
Speaker 2: you want to extend your duration before the rate cuts begin.
Speaker 2: In fact, we saw rates move down appreciably in August
Speaker 2: following the most recent the CPI data point was very benign.
Speaker 2: We've seen the restatement of labor data, which says, hey,
Speaker 2: the labor market, while it's still healthy, it's much less
Speaker 2: overheated than we previously thought. It seems like the bond
Speaker 2: market is way ahead of both the stock market and
Speaker 2: the Fed. How do you look at this?
Speaker 3: Markets are great about getting ahead of the next cycle,
Speaker 3: and we have seen that. We've seen interest rates coming
Speaker 3: down across the curve even before the Fed has moved.
Speaker 3: We think, though it's not too late, you're still going
Speaker 3: to get There's some uncertainty about how quick the Fed
Speaker 3: is going to cut, how quickly their yield curve is
Speaker 3: going to reshape. So we're even using some of these
Speaker 3: days when rates go back up a bit, those are
Speaker 3: good entry points or better entry points to come back
Speaker 3: to bonds. So we don't think it's too late, and
Speaker 3: I think that the investors could rethink their strategy today
Speaker 3: to kind of get ahead of the next wave of cuts.
Speaker 2: So that's the perfect segue into investors who are interested
Speaker 2: in fixing come and yield. What should these folks be
Speaker 2: doing right here at the end of the summer in
Speaker 2: twenty twenty four and heading into the fourth quarter.
Speaker 3: I would say, think about your cash position. What are
Speaker 3: you using that cash for. If it needs to be
Speaker 3: liquid for expenses and emergency fund, keep it there. But
Speaker 3: if it's part of your investment portfolio and you're just
Speaker 3: seeking the highest amount of income, you should think through
Speaker 3: what are the return to expectations over the next three, five,
Speaker 3: ten years and really use the opportunity to get that
Speaker 3: asset allocation back on track, that stock and bond mix
Speaker 3: and move out to some of more intermediate duration, because
Speaker 3: we think that's really where you're going to see the
Speaker 3: biggest change in interest rates and you could get the
Speaker 3: most both price appreciation as well as still some pretty
Speaker 3: compelling income.
Speaker 2: And our final question, how should investors be thinking about
Speaker 2: the risk of longer duration fixed income paper?
Speaker 3: So longer duration fixed income paper does have almost equity
Speaker 3: like volatility. It does have of double digit of volatility.
Speaker 3: We do see it as a very efficient hedge against
Speaker 3: equity markets. So if equity markets fall, we tend to
Speaker 3: see that flight to quality and investors go towards those
Speaker 3: long duration especially treasuries.
Speaker 1: We have a.
Speaker 3: Treasury ETF TLT it's twenty plus years. It actually saw
Speaker 3: the highest amount of inflows of any ETF vehicle in
Speaker 3: the month of August because people were trying to hedge
Speaker 3: some of that equity market volatility. So if you have
Speaker 3: a portfolio that's very heavy in equities eighty ninety plus percent,
Speaker 3: you could add a little bit of long duration bonds
Speaker 3: and that would help smooth out the portfolio returns over time.
Speaker 3: So that's really the role that we think of with
Speaker 3: longer duration bonds.
Speaker 2: So to wrap up, investors who have been enjoying five
Speaker 2: percent yields in money market and managing very short term
Speaker 2: duration bond portfolios should recognize, hey, rakecuts are coming. Jerome
Speaker 2: Palse said they were coming. This cycle is likely to
Speaker 2: last more than just a cut or two. The bond
Speaker 2: market is already starting to move yields down, and if
Speaker 2: you wait too long, you're going to miss the opportunity
Speaker 2: to lock in long duration, higher yielding bonds as the
Speaker 2: cycle begins. I'm Barry Redolts and this is Bloomberg's at
Speaker 2: the money is it is