What is a short duration bond?
A short duration bond is a bond with a short time to maturity. In the sterling market we define this as a bond maturing within the next five years, in order to access an optimal level of market depth and diversification. The short duration maturity profile may differ slightly for deeper fixed income markets, for example within the US or European credit markets short duration is more likely to be considered as bonds maturing within the next three years.
The concept of duration is very important for fixed income investors as it essentially measures how sensitive a bond’s price is to interest rate movements. Buying a corporate bond with a lower maturity provides investors with not only a lower duration but also a lower spread duration. This means that the bond will exhibit a lower sensitivity to changes in government bond yields as well as credit spreads. Short duration bonds can therefore be a very useful tool in managing the risks of rising yields and market volatility.
View from Square Mile Research
In this Talking Factsheet from the Square Mile Academy of Funds, Head of Risk Based Solutions Research Alex Farlow, outlines his view of the AXA Global Short Duration Bond Fund and reviews the Fund’s objectives and risks.
Why Short Duration?
Ability to mitigate the impact of market volatility
By the nature of a lower duration and spread duration, short duration investing offers lower volatility and drawdowns when compared to the wider, all maturities markets. Short duration bonds are less sensitive to credit spread movements compared with longer duration bonds, implying lower volatility of returns than the broad market. This is predominantly because the price of bonds that are closer to maturity tends to be close to par than longer duration bonds, and the discounted value of coupon payments is less sensitive to changes in interest rates.
Lower sensitivity to rising interest rates (yields)
One of the key risks of investing in fixed income is the capital eroding effects of rising yields. While we currently face a low (and in some countries negative) interest rate environment, should central bank policies prove to be successful and global growth picks up, investors are likely to face rising interest rates. Interest rates and bond prices usually move in opposite directions, therefore rising yields could have an adverse impact on bond prices. Due to their shorter maturities, short duration bonds can mitigate losses in periods of rising interest rates, as cash flows from maturing bonds can be reinvested at higher rates in the market.
Better liquidity than long duration bond funds
Exhibiting a naturally attractive liquidity profile, due to regular cash flows from maturing bonds and coupon income, enables a short duration strategy to minimise turnover when implementing active strategies. Holding bonds until their maturity also implies lower transaction costs, which can improve returns over the long term. Fixed income indices traditionally exclude bonds with maturities of less than one year.
The risk versus return profile
In a low interest rate environment, short duration bonds can offer an intermediate step into riskier asset classes for investors seeking incremental yields. Investors may consider looking beyond domestic markets towards Asia, high yield and emerging markets, where short duration products can offer an attractive risk-return profile.
AXA IM's short duration offering
AXA Investment Managers offers a wealth of experience in managing short duration bond strategies built over various market and economic cycles. We currently manage over £23 billion of short duration bond assets* in different markets around the world and can demonstrate a track record stretching back over 10 years.
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