It is the combination of demographics and the pressure on pension funds, not just in Europe but increasingly in North America, to match their putative long-term liabilities, which has ‘forced’ funds to allocate   will have some form of duration index target, and as with MBS and convexity, this also engenders a form of risk. As noted above, when yields rise the duration of a ‘plain vanilla’ government or corporate bond  the issuance of new longer-dated debt and the exit of shorter dated  environment, as the higher coupons on new issuance de facto lowers  is a rising risk that those matching duration indices may well become ‘forced sellers’ in order to match the moves in the index. In passing, it is worth taking on board that when the US Treasury announced the $42 Bln total increase in auction sizes at its quarterly refunding, there was a $30 Bln increase (for the quarter) for 2 and 3 Yr Treasury notes and 2 yr Treasury FRNs, and just $12 Bln for 5, 7, 10 & 30 yr Treasuries, which at the margin will also drag some duration indices, though not those typically used by pension funds, which tend to look at over 5 or over 15 year indices.


Be that as it may, there is another aspect to a more emphatic rise in yields, which relates to the very protracted period of low yields and the concomitantly low level of coupons on outstanding debt. For bond  the bonds via way of the income from coupon payments, which means that the total return on any given bond is rather better than the price drop implies. However this also means that lower coupon bonds have less ‘protection’, and indeed this also ‘doubles down’, as the prices of lower coupon bonds are more sensitive to a rise in yields than higher coupons, because the duration of the low coupon bonds is higher. To  and principal) discounted at current yields. The sensitivity of a bond  are structured - for lower coupon rate, the relative weight of coupon  repayment.


The latter poses a particular conundrum for those countries (Europe and Japan), which have opted for zero or negative interests, and have as a result seen short to medium dated yields in negative territory, in many cases for a very protracted period. The countries have on the one hand  hand bond holders have no coupon protection as yields, which in turn will likely exacerbate any rise in yields until they drop through their ‘par redemption’ value


Marc Ostwald E: marc.ostwald@admisi.com T: +44(0) 20 7716 8534


6 | ADMISI - The Ghost In The Machine | January/February 2018


Page 1  |  Page 2  |  Page 3  |  Page 4  |  Page 5  |  Page 6  |  Page 7  |  Page 8  |  Page 9  |  Page 10  |  Page 11  |  Page 12  |  Page 13  |  Page 14  |  Page 15  |  Page 16  |  Page 17  |  Page 18  |  Page 19  |  Page 20  |  Page 21  |  Page 22  |  Page 23  |  Page 24  |  Page 25  |  Page 26  |  Page 27  |  Page 28