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Bond Fund Duration: An Art, Not a Science

Duration can provide guidance, but not certainty.

The 2008 financial crisis and the resulting market shocks had a number of surprising consequences. One that was particularly important to bond investors was the degree to which diversified bond funds struggled or lost money, even though investors the world over were scrambling into U.S. Treasuries. Take the long-term government and long-term bond Morningstar Categories. Most of the time, funds in these two groups are expected to have pretty similar risks—they both focus on bonds with long maturities and relatively high-quality debt. Yet the divergence in their 2008 performances was breathtaking: The average long-term government fund gained nearly 28%, while the average portfolio in the long-term bond category—funds that hold mostly nongovernment, but investment-grade bonds—fell by more than 3.7%. Why?

Bumping up Against the Limitations of Interest-Rate Duration
Under normal circumstances, most high-quality bond portfolios' effective durations would have provided guidance about how those funds would respond to Treasury market shifts. Funds in both categories have occupied a wide range of duration territory, but not enough to explain such a broad dispersion of returns. And if that weren't odd enough, a nearly inverse phenomenon occurred as the market snapped back from the financial crisis in 2009.