Core bond funds slow their roll on duration

Core bond fund managers increased the duration of their funds from 2010 to 2018 as interest rates entered a general holding pattern. This move to increase rate sensitivity was likely driven by the Federal Reserve discount rate's sustained period of "lower for longer" that suppressed yields on shorter term bond issues and forced investors further out on curve.

The action appeared to work, as most managers outperformed the benchmark Bloomberg Barclays U.S. Aggregate Total Return index. Over the trailing 10-year period, 97% of core bond funds beat the benchmark by an average of 1%. The index returned 3.9% over the same period.

Since the start of 2019 managers have been pulling back on duration, preparing themselves for what many assumed was going to be a rising rate environment. However, the Fed — along with other central banks — through both rhetoric and action, chose to reverse course and lower the discount rate. This move coupled with volatile equity markets pushed global bond rates to alarming lows so in the first half of August. While this shift has been good for high duration managers, what happens next could be cause for concern should rates increase.