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The Basis Quarterly: Hedging Duration Risk

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The Basis is a quarterly presentation series by our Liquid Markets Group’s Multi-Asset Solutions team providing investors with insights into derivative structures and strategies, portfolio construction and other whole-of-portfolio investment topics.

In this edition, we dive deeper into one of the topics in this quarter’s The Basis: the benefits of duration hedging.

 

Credit sector construction can cause duration mismatch1

Fixed income sectors may invest across structures, public and private markets, and credit ratings. This flexibility allows investors to exploit a range of investment opportunities but may lead to unintended duration tilts. For example, the chart shows the mismatch between a commonly used fixed income benchmark and an off-benchmark asset mix that invests in corporate debt and leveraged loans.2

Figure 1

This mismatch can be hedged using a duration overlay

A duration overlay can be used to adjust overall portfolio duration. This reduces duration risk and can provide a better alignment with the relevant benchmark3. The overlay can be constructed using liquid futures contracts and requires only partial funding, making it capital efficient. The chart shows how a duration shortfall can be addressed using a duration overlay.


A duration overlay can reduce duration risk and tracking error 

A duration overlay can be used to adjust overall portfolio duration. This reduces duration risk and can provide a better alignment with the relevant benchmark3. The overlay can be constructed using liquid futures contracts and requires only partial funding, making it capital efficient. The chart shows how a duration shortfall can be addressed using a duration overlay.

 

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Further information

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