Morningstar - Q4 2020 - 17

Dispatches

Global Briefs
TRENDS

A Downturn is a decline in the stock market
from its month-end peak by 20% or more.

An Expansion runs from the end of a recovery until
the next month-end peak before a 20% decline.

Rising Risk in the High-Quality Bond Market
Since the 2008 global financial Downturn
crisis, the overall
duration of the Morningstar US Core Bond Index
has crept upward, spiking during the COVID-19
pandemic. At the end of 2007, its duration was 4.5
years, right in the 4- to 5-year range that had
characterized this market for years. By the end of
August 2020, its duration stood above 6 years.
That's largely because the U.S. Treasury and
investment-grade corporate sectors have grown

Market
Value

Morningstar US Treasury Bond Index
Morningstar US Corporate Bond Index

tremendously: At the start of 2008, the two
composed roughly 40% of the overall high-grade
sector; by August 2020, that figure was 64%.
Meanwhile, agency mortgages-which tend to
have shorter durations-have grown at
a much slower pace.

A Recovery runs from the month-end bottom to
when the market returns to its previous peak.

rates. Of the
features that underpin duration and
Expansion
Recovery
interest-rate sensitivity, longer maturities and
shriveling coupons are right near the top. Combine
that with massive growth, and you have
changed the very nature of the market itself.

It's not just that the Treasury and high-grade
companies are borrowing more. They are
also taking advantage of low long-term interest

Morningstar US MortgageBacked Securities Index

Eric Jacobson is a manager research strategist
with Morningstar.

Morningstar US Core Bond Index

$10T

Eﬀective
Duration
7 Years

The duration of the bond market has risen as agency
mortgages have become a smaller percentage.

8

$8.7
6

08/2020 6.0 Years

$6.5
$6.3

12/2007 4.5 Years

6

4

5

4

Cumulative Growth
US Corporate Bond Index
US Treasury Bond Index
US Mortgage-Backed Index

2

369%
368%
97%

3

0

2
12/31/2007

12/31/2009

12/31/2011

12/31/2013

12/31/2015

12/31/2017

08/31/2020

Source:
Data
as of 08/30/2020.
Source: Morningstar
Morningstar.Direct.
Data as
of 11/30/2017

A Brave New
Bond World
AMERICAS

United States
There's a challenge creeping up on bond
managers-and by extension fund shareholders-
that has thus far been met with the sound of
crickets, but it's a big one.

Falling market yields would typically prompt
the idea of dramatically shortening a portfolio's
duration, and vice versa. Effectively, the idea
would be to take less risk after high-quality bonds
have rallied (when their yields fall) and to add
risk after they've lost ground and their yields have
gone up. In other words: Buy low, sell high.
There are some managers who make that process
the heart of a strategy, but most employ some
version of a "buy low, sell high" philosophy within
the framework of a constrained approach to

interest-rate risk. That usually means using an
index as the anchor from which to tether a
portfolio's duration, plus or minus some margin of
years or percentage of the benchmark's.
That has arguably been a great success story
for mutual fund investors. Until the early 1990s,
most fund managers had freedom to manage
duration more broadly but were eventually caught
in the switches by sharp interest-rate shocks,
and it became clear just how difficult it was to win
consistently with interest-rate bets. Fidelity was

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17
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Morningstar - Q4 2020

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