Last updated: 18:02 / Friday, 2 August 2013
White paper By Robeco

Zero Duration to Protect Against Rising Yields

Zero Duration to Protect Against Rising Yields

Yields on US and European government bonds rose after reports that the Fed could begin tapering back its bond purchases later this year if the US economy keeps improving. Figure 1 shows the 5-year German Government Bonds and US Treasury yields (in %).

Currently, the Fed is buying USD 85 billion each month in treasury paper and mortgage-backed securities to stimulate economic and jobs growth. Bond investors expect this to be the starting point of a Fed policy that is less accommodating to the bond market. They fear that the Fed might raise short-term interest rates after 2015 in order to fight inflation.

In the euro zone, the situation is different: the ECB has pledged that interest rates will remain at record lows far into the future. The euro-zone economy is still weak.

Figure 1: 5-year German Government Bonds and US Treasury yields (in %)

Source: Bloomberg

Zero-duration stragtegy - how does it work?

Robeco offers a Zero-duration variant that protects regular bond strategies against a rise in the long-term interest rates, while investors can still try to take advantage of higher credit spreads.

The Zero-duration strategy invests in the existing portfolio and includes an interest-rate hedge. This hedge lowers interest-rate sensitivity by swapping the 5-year interest rate for the money-market rate (Libor 3 months). This means that Robeco pays the fixed interest rate while receiving the floating interest rate. The result is a lower sensitivity to interest rates. The investor can still benefit from potential credit-spread tightening. The expected returns on high-yield bonds are twofold: the credit spread and the interest rate. The swap makes the interest-rate component variable. When government bond yields rise, the Zero-duration strategy is expected to outperform the regular bond strategy.

Implementing this hedge lowers the yield of the portfolio. This difference currently amounts to about 1.5%. As the current duration of the Robeco High Yield fund is around 4.4 years, the interest rates only have to rise by about 35bps in order to break-even between both share classes (duration x rate increase) and to compensate for this yield give-up. In a scenario of stronger rate increases, the Zero-duration strategy is expected to deliver higher total returns than the regular share class.

Robeco offers Zero-duration variants for High Yield Bonds, Investment Grade Corporate Bonds and Financial Institutions Bonds

Alan Van der Kamp, client portfolio manager at Robeco, goes into further detail about the zero duration strategy in this 3 minute video.

You may also access the complete whitepaper by Robeco about Zero Duration strategies through this link.