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Tag: duration

The End

The End

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Is this the end? Are you my friend?
It seems to me, you ought to be free.
You used to be mine when the chips were down.
You used to be mine when I weren’t around…
– The Doors.

Those immortal lyrics spring to mind courtesy of this Citi survey of investors:

I’ve been surprised by the suddenness with which markets appear to have shifted gears from an apparent six-year reliance on easy monetary policy to pinning their hopes on the expectation of fiscal stimulus that is still far from materializing. We’ve touched on it in our various coverage at Bloomberg but it seems this will be the theme to watch in 2017. How rapid is the tightening? How pervasive? And, crucially, can the market remain relatively resilient in the face of rising rates and investors who still have a massive long position on credit?

Speaking of which, as is becoming tradition around here, here’s this year’s list of credit coverage. You’ll notice it peters out as the year goes by. That’s because I got busy with a new home and some new work. See you in the new year and here’s hoping your 2017 be filled with all the right kind of surprises.

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A short lesson in duration, from some long Petrobras bonds

A short lesson in duration, from some long Petrobras bonds

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Earlier this week, Petrobras, the scandal-ridden, junk-rated state-controlled Brazilian oil producer, sold $2.5 billion worth of 100-year bonds.

The idea of these century-long bonds sent some tongues wagging about so-called duration risk. This is one of the more esoteric topics in bondland, but can roughly be defined as the sensitivity of a bond’s price to changes in its yield. The greater a bond’s duration, the more sensitive its price is to changes in its yield. With investors putting their money in Petrobras bonds for 100 years, so the thinking goes, these bonds are heavily exposed to the movement of interest rates. But is this the case?

One way of measuring duration is to look at something called PV01 on your (handy!) Bloomberg terminal.

This tells you by how many cents would the bond price changes following a 1 basis point move in yield. For Petrobras’s new century bonds, it’s less than 10 cents.

How does that stack up against some other bonds? For comparison, Petrobras’s bonds due in 2044 have duration of roughly $1.16.

Now I don’t mean to say that the 100-year Petrobras bonds aren’t risky. Investors still have to consider interest rates. And they have to think about what the Brazilian economy and the Brazilian government and the global oil market and Petrobras, still in the midst of a massive corruption investigation, will look like over the course of a century.

But duration risk for these bonds is not as high as it might be given investors are being compensated with a relatively high coupon and yield. Where duration risk is a concern is with all those low-yielding government bonds where that might not be the case. As Mark Holman at TwentyFour Asset Management points out, the duration of those 100-year Petrobras bonds is roughly equivalent to the duration of the current 10-year German Bund which, at the time of writing, has a yield of just  0.66 percent and a coupon of 0.5 percent.

The lesson: maturity ≠ duration.

Also, duration risk can crop up in unexpected places.

New column – The unbearable tightness of benchmarks

New column – The unbearable tightness of benchmarks

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Benchmarks.

Their importance in financial markets cannot be overstated. So here’s a look at how the makeup of one particular benchmark bond index is making life difficult for big investors and in some cases encouraging them to use derivatives to introduce artificial duration to their portfolios.

(Writing about duration is always a huge hassle, but it too is very important in financial markets, so I try)

Here’s an excerpt:

If there were a recipe for creating the Barclays US Aggregate Index — one of the most important benchmark bond indices in the world — it might go something like this: take some US Treasuries, add a smattering of corporate bonds and securitised debt, then fold in a large chunk of mortgage-backed securities. Mix it all together et voilà — you are ready to serve a heaping portion of fixed income exposure to hungry investors around the world.

Fund managers are like chefs, trying to follow this basic recipe and improve on the outcome where possible — baking the basic bond fund cake, but adding their own twist to beat the benchmark. (After all, if you are simply replicating the benchmark’s returns, you had better be chargingvery low fees.)

However, fund managers seeking to outperform the Barclays “Agg” face a unique problem in the market in the shape of a severe lack of ingredients, and there are lurking concerns as to just what exactly fund manager cooks are reaching for in the kitchen.

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Bond index mix creates ingredient shortage