Short or long maturities for bonds?

On the bond side, investors are currently asking themselves which maturities are appropriate in the current market environment. In fact, this question is somewhat more difficult to answer than usual. The reason for this is the currently prevailing inverted yield curve.

In ‘normal’ times, a rising yield curve prevails. This means that investors usually receive a higher yield on long-dated bonds than on short-dated bonds or even floating-rate bonds. However, long-dated bonds are more volatile due to their higher interest rate sensitivity (duration). If yield levels at the long end of the yield curve rise, investors with long-dated bonds suffer price losses - an experience that many investors had to painfully learn in 2022.

A certain amount of interest rate risk may be desirable

From an overall portfolio perspective (including equities), this higher volatility is consciously accepted, as yield levels generally fall in negative economic scenarios and the associated price gains on long-dated bonds can counteract the price losses on equities that usually occur in this case.

The extent of this diversification potential depends, among other things, on the level of yields. The higher they are, the more room there is for falling yields and correspondingly rising bond prices. Currently, long-term yields are at comparatively attractive levels, especially when compared to 2-3 years ago. The 10-year US Treasury yield is currently 4.5 %, and German Bunds 2.4 % (as at 12 April 2024). The possibility for falling yields is therefore certainly present. Should the yields on the 10-Year Treasury fall to 3.0% or even lower over the next few months - e.g. due to an economic slowdown or even a recession - investors could realise double-digit price gains with these bonds. For hedging reasons alone, investing in long-term bonds can therefore make sense from an overall portfolio perspective.

Past performance is not a guide to future performance.

Source: Bloomberg, 29 February 2024 The scenarios are an estimate and are not guaranteed.

The inverted yield curve complicates decisions

However, from the perspective of the interest rate markets, we are not living in ‘normal’ times. Interest rates are higher at the short end of the yield curve than at the long end. This means that investors can currently collect higher coupons with short-dated bonds, and at the same time with a significantly lower interest rate risk than with long-dated bonds. This is of course particularly valuable in a scenario in which yield levels continue to rise, e.g. due to a renewed acceleration in inflation, which currently seems rather unlikely but cannot be completely ruled out.

Short-dated bonds can also make sense on the corporate bond side. Although the difference in yield between short and longer-dated securities is smaller for corporate bonds than for Bunds (see chart below), short-dated corporate bonds also have a lower risk, not only in terms of interest rate risk (duration) but also in terms of sensitivity to credit spreads (spread duration). In our view, this means that investors can currently achieve attractive returns with short-dated corporate bonds at moderate risk.

Past performance is not a guide to future performance.

Source: Refinitiv, 31 March 2024. 10+ Year German Bunds = ICE BofA 10+ Year German Government Index, 1-3 Year German Bunds = ICE BofA 1-3 Year German Government Index, Euro Corporate Bonds = ICE BofA Euro Corporate Index, 1-3 Year Euro Corporate Bonds = ICE BofA 1-3 Year Euro Corporate Index.

A barbell strategy as a solution?

If you cannot decide between short and long maturities, you could also consider a barbell strategy, i.e. hedging against negative economic scenarios from an overall portfolio perspective using long-dated government bonds on the one hand, and collecting potentially attractive yields to maturity on short-dated corporate bonds or even variable-rate high-yield floating rate notes (HY FRNs) on the other.

The value of investments will fluctuate, which will cause prices to fall as well as rise and you  may not get back the original amount you invested.

The views expressed in this document should not be taken as a recommendation, advice or forecast.