Overcoming the duration hurdle in a rising rate environment

Core Plus Income Fund (WCPBX)

 

Duration (interest rate risk) and a rising rate environment

Duration is the measure of a bond’s price sensitivity (or value) to a change in interest rates. As interest rates increase, bond prices fall commensurate with their duration. Fixed income investments with a shorter duration can help mitigate the impact of rate increases as compared to similar investments with longer durations, keeping all other variables constant and equal.

Yield and active management matters

When comparing intermediate bond investments, an investor will want to look at a portfolio’s duration, yield-to-worst (YTW), investment allocation and maturity schedule (reinvestment schedule) to help discern the opportunity for a positive total return. YTW is the lowest potential yield (most conservative yield) that can be received on a bond without the issuer actually defaulting. YTW is calculated by using worst-case scenario provisions, including prepayments, calls and sinking funds. Furthermore, YTW is a forward-looking estimate that ignores capital gains.

The charts below illustrate how Core Plus Income Fund (compared to its benchmark) may be affected by rising interest rates, and how its current YTW can help offset the interest rate impact. .

Assumptions:

  • Hold portfolio metrics constant (i.e. duration, credit allocation, YTW, etc.)
  • Successive interest rate increases across all maturities
Core Plus Income as of 9/30/18 Scenario #1 Scenario #2 Scenario #3
Effective Duration 4.4 years 4.4 years 4.4 years
Interest Rate Increase/Shock (1 Day Increase) 50 bps 75 bps 100 bps
Impact on Portfolio Due Only to Duration (“Hurdle”) -2.20% -3.30% -4.40%
YTW (Assumed Annual Return) +3.44% +3.44% +3.44%
Total Expected Annual Return (1 Year from Rate Increase Above) +1.24% +0.14% -0.96%
Source: Bloomberg Analytics

 

Bloomberg Barclays U.S. Aggregate Bond Index as of 9/30/18 Scenario #1 Scenario #2 Scenario #3
Effective Duration 6.0 years 6.0 years 6.0 years
Interest Rate Increase/Shock (1 Day Increase) 50 bps 75 bps 100 bps
Impact on Portfolio Due Only to Duration (“Hurdle”) -3.00% -4.50% -6.00%
YTW (Assumed Annual Return) +3.46% +3.46% +3.46%
Total Expected Annual Return (1 Year from Rate Increase Above) +0.46% -1.04% -2.54%
Source: Bloomberg Analytics

 

As shown in the table above, ignoring capital gains and fund expenses, Core Plus Income Fund may hold up better than the benchmark for each demonstrated scenario of an interest rate increase.

In the intermediate bond space, being tactical matters.

Over the past three years, the U.S. bond market has been deemed unattractive with historically low interest rates and generally tight spreads, yet Core Plus Income Fund has generated alpha by being tactical. Our goal is to invest in sectors that we believe offer the best risk-adjusted returns, and as such,
our allocation will change significantly over time.

 

Core Plus Income Fund is an opportunistic and patient investment solution that is nimble enough to take advantage of changing market conditions instead of being locked into particular sector or credit quality allocations. This tactical nature enables the Fund to be well positioned to help overcome the duration hurdle in a rising rate environment.

 

How well are you positioned to overcome the duration hurdle?

Contact us to learn how Core Plus Income Fund can help your clients’ portfolios.


Performance data represents past performance, which does not guarantee future results. The investment return and the principal value of an investment in the Fund will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than the original cost. Current performance may be higher or lower than the performance data quoted. Performance data current to the most recent month end may be obtained at weitzinvestments.com.

Returns assume reinvestment of dividends and redemption at the end of each period, and reflect the deduction of annual operating expenses, which as stated in the most recent Prospectus is 1.09% (gross) of the Fund’s Institutional Class net assets. Returns also include fee waivers and/or expense reimbursements, if any; total returns would have been lower had there been no waivers or reimbursements. The Investment Adviser has agreed in writing to waive its fees and reimburse certain expenses (excluding taxes, interest, brokerage costs, acquired fund fees and expenses and extraordinary expenses) to limit the total annual fund operating expenses for Institutional Class shares to 0.40% of the Class’s average daily net assets through July 31, 2019.

Investors should consider carefully the investment objectives, risks, and charges and expenses of the Fund before investing. The Fund’s Prospectus contains this and other information about the Fund and should be read carefully before investing. The Prospectus is available from Weitz Investment Management, Inc. Weitz Securities, Inc. is the distributor of the Weitz Funds.


Weitz Investment Management1125 South 103rd Street, Suite 200, Omaha, NE 68124800.304.9745weitzinvestments.com