If interest rate are forecasted to rise, the best strategy is “Total return”.
and the answer explain that, short duration bonds should be purchased and long duration bonds should be sold short. i don’t quite understand this statement. can someone please elaborate on this statement?
thanks!
Duration is a measure of interest rate sensitivity - the greater (longer) the duration, the more price sensitive it is. A forecasted rise in interest rates will have a greater negative impact on the pricing of long duration bonds as compared to shorter duration bonds.
Another way to evaluate is to keep in mind that returns are typically measured against a benchmark. If the weighted average duration of the benchmark is say 6 years and we are running a portfolio in-line with the benchmark in duration terms, a manager who expects rates to rise will shorten duration to less than 6 in an attempt to outperform his/her relative benchmark on a relative basis.