Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 196

Interest rate duration: how exposed are you?

It is no secret that Federal Reserve Chair Janet Yellen is preparing the market for higher interest rates, but how many investors and their advisers know how exposed their portfolios are to meaningfully higher interest rates?

We have been doing the client rounds lately and have been taken aback by how intimidated some clients seem to be by the world of fixed income, and particularly the notion of interest rate duration. Eyebrows rise when we walk them through the potential impact of higher interest rates.

The effect of a general rise in interest rates is straightforward. A bond’s interest rate duration is a measure of its price sensitivity to changes in interest rates. The greater the time to maturity, the longer it takes to receive all the coupons and principal back, and hence generally the more exposed to a change in market interest rates.

A simple way to think about duration

If a bond has a duration of five years, for example, for every 1% move in the nominal level of market interest rates, its price will move by about 5%. In other words, if market interest rates were to rise by approximately 3%, the capital value of the bond would fall by around 15%.

To take the issue of interest rate duration to the next level, and indeed to start to apply some magnitude, it is important to understand how low interest rates are around the world:

There have been some shorter-term peaks and troughs, but the long-term trend has been going down for decades. Market interest rates went negative in Japan and Germany, and some parts of their interest rate curves still are. However, we now think that we have seen the inflection point in this long-term trend.

The US is a good example. For the better part of a decade, official US rates have been at or below 1%. For a considerable part of this period, the Federal Reserve was injecting huge amounts of liquidity into the system via their quantitative easing program. So, will a more normalised level for US rates longer term be at a lower peak than previous as most of the market is expecting today? Or with the enormous amount of stimulus that has been injected into the US economy over the past eight years, could the peak in the next cycle be notably higher than the market is currently expecting?

Note that prior to the GFC, official US rates peaked at 5.25%, over 4% above where they are today. Additionally, in the 20 years prior to the 5.25% peak, official US rates still averaged just under 5%.

On-the-ground concern about inflation

When we talk to US companies, for the first time in a while we are hearing management report that they are competing for staff and this is pushing up wages. Unemployment in general is low and we are well into the recovery in the US housing market.

Additionally, for years now many US companies have been borrowing at very low rates, in some cases less than 3%, and sometimes with time horizons as long as 10 to 15 years. They are investing that capital back into their businesses, often with the objective of earning around 10-20% type returns or higher.

All of these points will likely feed into growth and inflation over time, suggesting that interest rates should move materially higher in the US in the medium to longer term. This potentially has significant implications for interest rate securities, especially those with meaningful duration.

At PM Capital, we have in effect removed all interest rate duration from our portfolios. This should avoid material negative capital falls due to higher rates, but also, as rates rise over time, the floating rate yields on the securities we own will ratchet up.

Investors should find out the interest rate duration of their fixed income portfolio. Only then can they make a proper assessment as to whether, in a rising interest rate environment, their investments are positioned to deliver the outcomes they are expecting.

 

Jarod Dawson is Director and Portfolio Manager at PM Capital. This article is general information that does not consider the circumstances of any individual.

RELATED ARTICLES

Red pill or blue pill? Navigating the matrix of fixed income

Fixed income investing when rates are rising

The best opportunities in fixed income right now

banner

Most viewed in recent weeks

16 ASX stocks to buy and hold forever, updated

This time last year, I highlighted 16 ASX stocks that investors could own indefinitely. One year on, I look at whether there should be any changes to the list of stocks as well as which companies are worth buying now. 

2025-26 super thresholds – key changes and implications

The ABS recently released figures which are used to determine key superannuation rates and thresholds that will apply from 1 July 2025. This outlines the rates and thresholds that are changing and those that aren’t.  

Is Gen X ready for retirement?

With the arrival of the new year, the first members of ‘Generation X’ turned 60, marking the start of the MTV generation’s collective journey towards retirement. Are Gen Xers and our retirement system ready for the transition?

Why the $5.4 trillion wealth transfer is a generational tragedy

The intergenerational wealth transfer, largely driven by a housing boom, exacerbates economic inequality, stifles productivity, and impedes social mobility. Solutions lie in addressing the housing problem, not taxing wealth.

What Warren Buffett isn’t saying speaks volumes

Warren Buffett's annual shareholder letter has been fixture for avid investors for decades. In his latest letter, Buffett is reticent on many key topics, but his actions rather than words are sending clear signals to investors.

The 2025 Australian Federal election – implications for investors

With an election due by 17 May, we are effectively in campaign mode with the Government announcing numerous spending promises since January and the Coalition often matching them. Here's what the election means for investors.

Latest Updates

World's largest asset manager wants to revolutionise your portfolio

Larry Fink is one of the smartest people in the finance industry. In his latest shareholder letter, the Blackrock CEO outlines his quest to become the biggest player in private assets and upend investor portfolios.

Economy

Australia's economic report card heading into the polls

Our economy grew by a nominal rate of 7% per annum from 2017 to 2024, but it benefited from the largesse of fiscal and monetary policies, both of which are now fading. We need a new, credible economic growth agenda.

Preference votes matter

If the recent polls are anything to go by, we are headed for a hung parliament at the upcoming federal election. So more than ever, Australians need to give serious consideration to their preference votes.

SMSF strategies

Meg on SMSFs: Tips for the last member standing

It’s common for people as they age to seek more help in running their SMSF if their capacity declines. An alternate director may be a great solution for someone just planning for short-term help in the meantime.

Wilson Asset Management on markets and its new income fund

In this interview, Matthew Haupt from Wilson Asset Management discusses his outloook for the ASX, sectors such as REITs that he likes, and his firm's launch of a new income-oriented listed investment company.  

Planning

‘Life expectancy’ – and why I don’t like the expression

Life expectancy isn't just a number - it's a concept that changes with survival rates over time. This article breaks down how age, survival, and societal factors shape our understanding of life expectancy, especially post-Covid. 

The shine is back on gold, and gold miners

Gold mining stocks outperformed in 2024 and are expected to do well in 2025. At this point in the rally, it's worth considering what has driven gold prices higher and why miners could still have some catching up to do.

Sponsors

Alliances

© 2025 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.