Doubleline's Baha: Don't Think Short Duration Bonds Are A Rate-Hike Panacea

Conventional wisdom seems to be that the best way to deal with looming interest rate hikes is by buying only short duration bonds, or dumping bonds altogether. But in a recent Forbes column, DoubleLine’s Bonnie Baha takes aim at those notions.

Baha says that tightening by the Federal Reserve is likely to lead to multiple contraction for equities, if history is any guide. “What about buying bonds with lower durations?” she asks. “Since 2008 that’s been a terrible strategy. Setting aside default risk, the ‘losses’ due to rising rates are realized only when securities are sold. Bond investors have historically been more concerned with income than capital gains. Remember, just because the price of your bond has declined, what you have really purchased is a cash-flow stream that under normal circumstances should continue, absent an event of default. So, if you had shortened your duration for the past six years, the result would have been a greatly reduced cash flow for many years and the loss of the compounding of that cash flow.”

She says the biggest contribution to returns over the life of a bond is the reinvestment of coupon interest. “Buy quality bonds in a laddered maturity portfolio where rising rates can work in your favor,” she writes.  “Obsessing over duration without considering credit risk, especially with regard to high-yield corporate bond funds, is foolhardy.”

“Remember, the point of a bond portfolio is to generate income, but if that income stream ceases due to a default you not only lose your income, but you’re stuck with a security that’s in financial purgatory, whose maturity, just like Beckett’s Godot, will never arrive,” Baha says.