Investors in long-term Treasuries are facing losses due to higher yields. Duration and bond math play a crucial role in mitigating risks. Categories: Finance, Investments, Bonds. Tags: long-term Treasury investments, duration, bond math, yields. Keyw...
Troy D. Hanson
September 11, 2023
Investors who have purchased long-term Treasuries, often seen as risk-free assets, have recently experienced significant losses. However, there are certain factors, such as duration, that provide some reassurance and suggest that the worst of the losses may be behind them.
The Pressure on Government Bonds
In August, government bonds came under pressure, resulting in a surge in yields. The yield on a 10-year bond reached 4.339%, the highest level since the last financial crisis. While yields have slightly eased to 4.257% as of Friday, they still remain higher than July's levels and have experienced a notable increase since the pandemic low of 0.501% on March 9, 2020. Consequently, the iShares 20+ Year Treasury Bond exchange-traded fund (TLT) has seen annualized losses of 15% over the past three years.
Factors Driving Higher Yields
The question isn't what has driven yields higher, but rather, what hasn't. Higher inflation, along with the corresponding need for higher interest rates, has led investors to demand a greater premium to hold longer-dated bonds. Additionally, the substantial bond issuance by investment-grade companies, almost $50 billion in just two days (Tuesday and Wednesday), compared to the $64.6 billion seen throughout August, has further pressured long-dated Treasuries. Investors now require higher yields to participate in such deals.
Persistent Struggles for the 10-Year Treasury Note
The 10-year Treasury note has experienced a decline of 0.8% this year, including coupon payments up until Friday's close. This sets it on track for a third consecutive year of losses, an unprecedented occurrence throughout the 250 years of U.S. history, according to analysts at Bank of America.
The Importance of Duration in Bond Investing
This discouraging situation raises a crucial question: Why should investors consider buying longer-dated government bonds this year? The answer lies in bond math, specifically a metric known as "duration." It is worth noting that duration can be mistaken for "maturity," as both terms suggest a passage of time in everyday language. However, in the bond market, they have distinct meanings. Maturity refers to the length of time until a bond issuer repays the principal to investors, while duration reflects a bond's sensitivity to changes in interest rates. A lower duration implies that investors will experience fewer losses when yields rise.
In summary, the current landscape presents significant challenges for those interested in long-term Treasury investments. However, by considering factors such as duration and understanding the dynamics of bond math, investors can navigate this environment more effectively.
Duration is on the decline in the bond market. As of Thursday, the metric for a 10-year government bond stood at 8.12, compared to 9.06 at the beginning of March 2022 when the Federal Reserve started raising rates. The drop in duration is even more pronounced for 30-year Treasuries, which have fallen from 21.85 to 16.789 over the same period. This suggests that even if interest rates continue to rise, bond prices should not experience the same significant drops seen earlier in the rate-hike cycle.
Renowned high-yield-bond analyst Marty Fridson advises investors to focus on yield gains rather than fixating on bond price fluctuations. According to Fridson, yields accounted for 87% of the annualized total return on 30-year bonds over the past 30 years. During that period, the 30-year bond yielded an average of 5.19%.
Chief Investment Officer at Lehmann Livian Fridson Advisors, Martin Fridson, concurs, stressing that a majority of gains come from income rather than bond price changes. He notes the reduced downside price risk in case interest rates continue to rise.
Investors who are weighing their options between fixed income and the stock market can find reassurance from the fact that the yield on a 30-year bond, which stood at 4.33% on Friday, is only slightly lower than the S&P 500 earnings yield of 5.09% recorded on Thursday. During the early stages of the pandemic, the 30-year bond only offered investors 16.6% of the S&P 500's total yield, indicating that bonds are currently relatively more attractive than before.
While no investment is completely risk-free, it is important to note that higher rates or inflation could potentially cause prices to fall even further. However, the decline in duration coupled with higher yields does provide some reassurance to bond enthusiasts.
In summary, the bond market is showing signs of stability and resilience, offering investors a potential avenue for steady income amidst a changing economic landscape.