Interest-rate risk is the major challenge for fixed-income investors, especially in this period of exceptionally low interest rates. To help walk readers through the issue, I welcome this post from Douglas J. Peebles and Wayne Godlin, AllianceBernstein’s chief investment officer and head of Fixed Income and senior portfolio manager of Fixed Income, respectively.
Don’t Be Caught Long: Strategies to Curb Interest-Rate Risk in the Municipal Market
Today, a municipal portfolio full of bonds with maturities in the 20-to-30-year range is exposed to the high risk of rising interest rates. Now may be the right time to shorten your duration and lower your credit quality.
Since yields are at all-time lows, some investors have been tempted into lengthening duration to earn a little more yield. But this is potentially dangerous, because the longer the duration, the greater the loss in value if interest rates rise.
Yields and prices move in opposite directions, and how much a bond’s price moves when rates change is determined by duration. Duration measures the sensitivity of a bond’s price to changes in the level of interest rates. In general, longer-maturity bonds have longer durations, so their prices rise more if interest rates fall, but also fall more if rates rise. In other words, the longer the duration, the greater the price volatility.