Insight into outperforming fixed income benchmarks during volatile times
Volatility in bond markets has not been this high since the mid-1990s, as traders try to make sense of uncertain economic growth prospects and the outlook for inflation in these unprecedented times.
Conversely, a manager could outperform the benchmark in a period of rising rates and falling prices if they had shortened their average term and duration. The longer the duration of the bond, the more it will move in price. For instance, the price of a bond with a two-year duration will fall less than 2 per cent if yields quickly rise by one percentage point; a bond with duration of 30 years will fall well over 10 per cent if yields rise by the same one percentage point.
During the early 2000s, many investment firms gave up on interest rate anticipation. As rates became less volatile, there were less significant moves to take advantage of. Managers would place a bet in one direction only to have it eventually reverse, resulting in underperformance. What we’re seeing right now is quite different. We have an inverted yield curve where shorter-term bonds are offering greater yields than those further out the curve. Late last month, for instance, we saw two-year government bonds yielding 3.19 per cent and 10 years only 2.84 per cent.
The market seems to be saying rates will not rise significantly, and may even fall. Given rates are still below current headline inflation, the market seems to be pricing in a drop in inflation. This isn’t unexpected given current demand suppression – when consumers and businesses stop buying goods and services – and general economic weakness.
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