Sensitivity to interest rate movements

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jtelwood
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Sensitivity to interest rate movements

Post by jtelwood »

I see numerous articles that state a mutual fund holding Treasuries is more sensitive to an increase in interest rates than other bond funds of similar duration. What is the reason for this difference in sensitivity?

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Call_Me_Op
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Re: Sensitivity to interest rate movements

Post by Call_Me_Op »

jtelwood wrote:I see numerous articles that state a mutual fund holding Treasuries is more sensitive to an increase in interest rates than other bond funds of similar duration. What is the reason for this difference in sensitivity?
This is not true. If durations are equal, interest rate sensitivity (for small rate changes) is identical - by definition. What is true is that for two funds having equal duration, the one with the higher interest rate will get you "back to even" sooner.
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garlandwhizzer
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Re: Sensitivity to interest rate movements

Post by garlandwhizzer »

Classically investment grade corporate bond funds are expected to do better in a rising yield environment than Treasuries. Two reasons. One, for a given duration, corporates pay higher interest than Treasuries due to perceived higher repayment risk. That means that if dividends are reinvested, your corporate bond fund buys more shares on the newly-issued, higher-yielding bonds than do Treasuries which increases the total yield of a corporate fund at a faster rate than a Treasury fund. Hence they are less severely impacted by rising rates than Treasuries, a lower yielding instrument. Second, rising interest rate environments are usually associated with improving economic activity and increasing inflation, both of which tend to decrease the repayment risk associated with corporate bonds which make payments in fixed nominal dollars. Therefore yield spreads between corporates and Treasuries tend to compress in a rising rate environment, an additional source of corporate bond outperformance.

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nisiprius
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Re: Sensitivity to interest rate movements

Post by nisiprius »

I think it's a tiny effect that is close to a technicality that's being made out to be much more than it is. Here's a chart of the Vanguard intermediate-term Treasury, and mostly-corporate Intermediate-Term Investment Grade, along with the 10-year Treasury rate. Well, the claimed effect is there--when interest rates rose, Treasuries fell more than corporates, and vice versa--but how important is it really going to be in your portfolio? It's not as if corporates had some magic immunity to interest rate changes. (Unlike bank CDs, which, assuming breakability, do not have interest rate sensitivity).

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Meanwhile, sensitivity to interest rate movements seems to me to be missing the forest for the trees. While to me bonds are just for safety--to dilute stock risk, not oppose it--and while a 10% drop in 2008-2009, when stocks (green) dropped 50%, doesn't seem like a big deal--nevertheless, at the time when you most wanted some help, corporates (blue) did take a 10% hit, while Treasuries (orange) were one of the very few non-derivative asset classes that actually went up. Hardly enough to matter much, but still... up. While corporates were going... you know... down.

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I am pretty comfortable with the diversification of Total Bond. I don't care to bet on whether corporates or Treasuries are the place to be. Bill Gross's bet against Treasuries in 2011 showed that not even experts can make that kind of call. It's not as simple as "corporates rule, Treasuries suck."
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Munir
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Re: Sensitivity to interest rate movements

Post by Munir »

The OP's question is about a rising rate environment and not 2008. Garland Whizzer's explanation was on target.

PS: graphs show varying results depending on the starting and ending dates of the graph. 2009 showed the opposite results from 2008 between treasuries and corporates when the corporates recovered and even exceeded the treasuries.
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