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.

RELATED ARTICLES

Duration: Friend or foe in a defensive allocation?

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

Fixed income investing when rates are rising

banner

Most viewed in recent weeks

Raising the GST to 15%

Treasurer Jim Chalmers aims to tackle tax reform but faces challenges. Previous reviews struggled due to political sensitivities, highlighting the need for comprehensive and politically feasible change.

7 examples of how the new super tax will be calculated

You've no doubt heard about Division 296. These case studies show what people at various levels above the $3 million threshold might need to pay the ATO, with examples ranging from under $500 to more than $35,000.

Are franking credits hurting Australia’s economy?

Business investment and per capita GDP have languished over the past decade and the Labor Government is conducting inquiries to find out why. Franking credits should be part of the debate about our stalling economy.

Here's what should replace the $3 million super tax

With Div. 296 looming, is there a smarter way to tax superannuation? This proposes a fairer, income-linked alternative that respects compounding, ensures predictability, and avoids taxing unrealised capital gains. 

The rubbery numbers behind super tax concessions

In selling the super tax, Labor has repeated Treasury claims of there being $50 billion in super tax concessions annually, mostly flowing to high-income earners. This figure is vastly overstated.

9 winning investment strategies

There are many ways to invest in stocks, but some strategies are more effective than others. Here are nine tried and tested investment approaches - choosing one of these can improve your chances of reaching your financial goals.

Latest Updates

Taxation

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

The Labor government is talking up tax reform to lift Australia’s ailing economic growth. Before any changes are made, it’s important to know who pays tax, who owns assets, and how much people have in their super for retirement.

7 key charts on the state of the Australian property market

The Australian property market stirs fierce debate - often bullish optimism versus crash predictions. But beyond the noise, seven charts reveal what's really driving prices and the outlook moving forward.

A simple alternative to the $3 million super tax

Division 296 aims to introduce improved fairness into the superannuation system, yet is overly complex. This scours the world for better ideas and suggests a simpler alternative which can achieve the same goals.

CBA and the index conundrum for super funds

After the hyperbolic rise in CBA shares, super funds are floating the idea of carving out the weightings of ASX bank securities and indexing them within their portfolios. This looks at why that might be a big error.

Strategy

10 policies to drive Australian productivity higher

Here's a comprehensive list of proposed reforms to fix Australia's stagnating economy, including introducing a flat income tax rate, reducing migration, and making childcare tax-deductible.

Interviews

Where to find big winners in Asia

As more money looks for a home outside the US, Asia may soon get some love. Fidelity's Anthony Srom outlines the best places in Asia to invest, including in Chinese consumer names, Indian financials, and Thailand.

Investment strategies

We have trouble understanding the time value of money

We overvalue the present and underestimate the future - it’s a cognitive glitch called hyperbolic discounting. It affects savings, spending, and loans, and it's more common - and costly - than we think. 

Sponsors

Alliances

© 2025 Morningstar, Inc. All rights reserved.

Disclaimer
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. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. 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.