Long duration assets

In a market environment of rising interest rates, assets with a long duration generally come under pressure. This category also includes stocks of growth companies that do not generate profits. A current example of this are stocks of unprofitable technology companies, which have lost more than 75% of their market capitalization on average since their peak. The reason is obvious: earnings, dividends or cash flows which are very far in the future have to be discounted at a higher discount rate today. Therefore, the asset value is lower than before the rise in interest rates. 

Long-duration assets in bonds 

Long-duration assets are not only found in equities, but also in the fixed income space. The decisive factor for the duration is the maturity of the bond, but also the level of the coupon. The lower the coupon, the higher the duration for the same maturity. In the low interest rate environment – or even negative interest rate environment in some countries – many government bonds were issued with a coupon close to zero. Some eurozone countries have issued bonds with an extremely long maturity, including Italy and Spain (50 years), Austria (70 years) or Ireland (100 years). These bonds have an enormously high duration and thus react very sensitively to a rise in interest rates. For example, the 100-year government bond of Ireland has lost over 75% of its value since its issuance in 2020 (graph 1). Despite this steep price decline, this government bond has only a yield to maturity of 2.6% per annum in nominal terms.

Volume of negative-yielding bonds shrinks

A little more than two years ago, the yield curves of several countries were in negative territory, including Switzerland and Germany. Following the latest interest rate hikes by the Swiss National Bank (SNB) and the European Central Bank (ECB), interest rates are now positive again – only parts of the Japanese yield curve are still in negative territory. This, of course, has a significant impact on the overall bond market. At the end of 2020, the volume of negative-yielding outstanding bonds amounted to almost USD 20 trillion globally. In the meantime, the amount has fallen to less than USD 2 trillion. 

Timing is crucial

After the sell-off in the bond market, the question arises as to when investors should increase duration in the bond segment again. Traditional bond indices in US dollars, euros and Swiss francs have lost around 15% this year. Indeed, we are already seeing opportunities in certain areas, such as two-year US government bonds, which are yielding around 4.1%. Nevertheless, we believe that patience will continue to be required as long as central banks – particularly the Federal Reserve and the ECB – continue to raise rates aggressively and real yields keep rising. Market timing thus becomes increasingly important. An overshooting of interest rates cannot be ruled out given the current volatility in the bond markets.