Ethenea: Why is active duration management fundamentally important?
Those who can analyse the yield curve and derive potential courses of action can manage their portfolios more effectively. The key to success is duration management.
The recent turmoil surrounding trade tariffs and geopolitical crises clearly demonstrates that performance becomes a challenge in turbulent times. To survive, you need flexibility and active management, as well as the full range of modern portfolio management tools – including active management of interest rate sensitivity.
What the yield curve reveals
The yield curve illustrates the relationship between a bond’s maturity and its yield. It acts as a barometer for economic expectations, inflation forecasts and monetary policy interventions. During normal market phases, yields increase with longer maturities, as investors require greater compensation for the increased risk of a longer capital commitment. However, if the curve is flat or inverted, this signals uncertainty or concerns about a potential recession.
Yield curves usually change in one of three ways: The most common is the level shift – a parallel shift of all yields upwards or downwards (around 77% of movements). Less common are changes in steepness (17%) or curvature, whereby short, medium and long maturities develop differently, providing indications of interest rate expectations or enabling targeted positioning.
Since changes in level and steepness account for most curve movements, these are the focus of many investor strategies. Depending on the market assessment, a distinction is made between so-called bull moves (falling yields) and bear moves (rising yields), as well as between steepeners (increasing steepness) and flatteners (decreasing steepness). These movements can also occur simultaneously.
Duration as a control lever in the bond portfolio
Duration measures how strongly the price of a bond reacts to changes in the yield to maturity (YTM). Specifically, duration indicates the percentage change in price when the yield rises or falls by 1% (i.e. 100 basis points). This calculation is based on the assumption that the entire yield curve shifts in parallel.
Mathematically, the duration is derived from the term and coupon rate of a bond. It considers all cash flows – i.e. interest payments and repayments – and weights them according to when they are received.
An example illustrates the effect: a ten-year German government bond with a duration of 8.5 would probably rise by 8.5% in price if yields fell by 100 basis points. This sensitivity allows active portfolio managers to deliberately take positions or reduce risks by adjusting the duration in a targeted manner. This can be done, for example, through futures or by selecting bonds with different maturities. Such control is particularly important in phases of increased volatility or diverging central bank policies.
Strategic positioning as the foundation for active management
In a dynamic market environment, it is crucial not to simply accept interest rate movements passively, but to actively change the portfolio positioning. This may involve adopting a higher or lower duration depending on how interest rates are expected to develop. Through strategic duration management, we can maintain control, increase opportunities in a targeted manner, and protect our investors' capital at the same time.
