Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 196

Interest rate duration: how exposed are you?

It is no secret that Federal Reserve Chair Janet Yellen is preparing the market for higher interest rates, but how many investors and their advisers know how exposed their portfolios are to meaningfully higher interest rates?

We have been doing the client rounds lately and have been taken aback by how intimidated some clients seem to be by the world of fixed income, and particularly the notion of interest rate duration. Eyebrows rise when we walk them through the potential impact of higher interest rates.

The effect of a general rise in interest rates is straightforward. A bond’s interest rate duration is a measure of its price sensitivity to changes in interest rates. The greater the time to maturity, the longer it takes to receive all the coupons and principal back, and hence generally the more exposed to a change in market interest rates.

A simple way to think about duration

If a bond has a duration of five years, for example, for every 1% move in the nominal level of market interest rates, its price will move by about 5%. In other words, if market interest rates were to rise by approximately 3%, the capital value of the bond would fall by around 15%.

To take the issue of interest rate duration to the next level, and indeed to start to apply some magnitude, it is important to understand how low interest rates are around the world:

There have been some shorter-term peaks and troughs, but the long-term trend has been going down for decades. Market interest rates went negative in Japan and Germany, and some parts of their interest rate curves still are. However, we now think that we have seen the inflection point in this long-term trend.

The US is a good example. For the better part of a decade, official US rates have been at or below 1%. For a considerable part of this period, the Federal Reserve was injecting huge amounts of liquidity into the system via their quantitative easing program. So, will a more normalised level for US rates longer term be at a lower peak than previous as most of the market is expecting today? Or with the enormous amount of stimulus that has been injected into the US economy over the past eight years, could the peak in the next cycle be notably higher than the market is currently expecting?

Note that prior to the GFC, official US rates peaked at 5.25%, over 4% above where they are today. Additionally, in the 20 years prior to the 5.25% peak, official US rates still averaged just under 5%.

On-the-ground concern about inflation

When we talk to US companies, for the first time in a while we are hearing management report that they are competing for staff and this is pushing up wages. Unemployment in general is low and we are well into the recovery in the US housing market.

Additionally, for years now many US companies have been borrowing at very low rates, in some cases less than 3%, and sometimes with time horizons as long as 10 to 15 years. They are investing that capital back into their businesses, often with the objective of earning around 10-20% type returns or higher.

All of these points will likely feed into growth and inflation over time, suggesting that interest rates should move materially higher in the US in the medium to longer term. This potentially has significant implications for interest rate securities, especially those with meaningful duration.

At PM Capital, we have in effect removed all interest rate duration from our portfolios. This should avoid material negative capital falls due to higher rates, but also, as rates rise over time, the floating rate yields on the securities we own will ratchet up.

Investors should find out the interest rate duration of their fixed income portfolio. Only then can they make a proper assessment as to whether, in a rising interest rate environment, their investments are positioned to deliver the outcomes they are expecting.


Jarod Dawson is Director and Portfolio Manager at PM Capital. This article is general information that does not consider the circumstances of any individual.


Red pill or blue pill? Navigating the matrix of fixed income

Fixed income investing when rates are rising

Christian Baylis on financial repression in fixed income


Most viewed in recent weeks

10 reasons wealthy homeowners shouldn't receive welfare

The RBA Governor says rising house prices are due to "the design of our taxation and social security systems". The OECD says "the prolonged boom in house prices has inflated the wealth of many pensioners without impacting their pension eligibility." What's your view?

House prices surge but falls are common and coming

We tend to forget that house prices often fall. Direct lending controls are more effective than rate rises because macroprudential limits affect the volume of money for housing leaving business rates untouched.

Survey responses on pension eligibility for wealthy homeowners

The survey drew a fantastic 2,000 responses with over 1,000 comments and polar opposite views on what is good policy. Do most people believe the home should be in the age pension asset test, and what do they say?

100 Aussies: five charts on who earns, pays and owns

Any policy decision needs to recognise who is affected by a change. It pays to check the data on who pays taxes, who owns assets and who earns the income to ensure an equitable and efficient outcome.

Three good comments from the pension asset test article

With articles on the pensions assets test read about 40,000 times, 3,500 survey responses and thousands of comments, there was a lot of great reader participation. A few comments added extra insights.

The sorry saga of housing affordability and ownership

It is hard to think of any area of widespread public concern where the same policies have been pursued for so long, in the face of such incontrovertible evidence that they have failed to achieve their objectives.

Latest Updates


$1 billion and counting: how consultants maximise fees

Despite cutbacks in public service staff, we are spending over a billion dollars a year with five consulting firms. There is little public scrutiny on the value for money. How do consultants decide what to charge?

Investment strategies

Two strong themes and companies that will benefit

There are reasons to believe inflation will stay under control, and although we may see a slowing in the global economy, two companies should benefit from the themes of 'Stable Compounders' and 'Structural Winners'.

Financial planning

Reducing the $5,300 upfront cost of financial advice

Many financial advisers have left the industry because it costs more to produce advice than is charged as an up-front fee. Advisers are valued by those who use them while the unadvised don’t see the need to pay.


Many people misunderstand what life expectancy means

Life expectancy numbers are often interpreted as the likely maximum age of a person but that is incorrect. Here are three reasons why the odds are in favor of people outliving life expectancy estimates.

Investment strategies

Slowing global trade not the threat investors fear

Investors ask whether global supply chains were stretched too far and too complex, and following COVID, is globalisation dead? New research suggests the impact on investment returns will not be as great as feared.

Investment strategies

Wealth doesn’t equal wisdom for 'sophisticated' investors

'Sophisticated' investors can be offered securities without the usual disclosure requirements given to everyday investors, but far more people now qualify than was ever intended. Many are far from sophisticated.

Investment strategies

Is the golden era for active fund managers ending?

Most active fund managers are the beneficiaries of a confluence of favourable events. As future strong returns look challenging, passive is rising and new investors do their own thing, a golden age may be closing.



© 2021 Morningstar, Inc. All rights reserved.

The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. Any general advice or ‘regulated financial advice’ under New Zealand law has been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892) and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. For more information refer to our Financial Services Guide (AU) and Financial Advice Provider Disclosure Statement (NZ). You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.

Website Development by Master Publisher.