Aegon Asset Management: Duration risk – it's more than just a number

Bond markets are enduring one of their most uncertain and volatile periods in recent memory.  Market consensus views have been formed and abandoned in response to the changing macro and political backdrop, resulting in an environment where high-conviction views about the market outlook are more difficult to find. While uncertainty might not be everyone’s best friend, the volatility it brings supports a strong argument in favor of active duration risk management.

There are three levers that can shape how investors view and manage duration risk:

1. The overall level of duration
2. Market selection
3. The yield curve positioning

The first of these tends to get the most attention. However, this year,  having conviction about market direction has been a challenge. Why? The risk/reward of large, directional duration positions was unattractive as the blizzard of new (and often contradictory) information made growth, inflation and central bank forecasting increasingly difficult.  

Instead, many investors tend to favour an average level of overall duration that can be adjusted higher or lower depending on valuations and place greater emphasis on the other two levers: market selection and yield curve positioning.

Market selection and duration

While the direction of yields has been more difficult to predict, picking the markets you want to own versus those you don’t might have been a more productive approach to adding value. Across core markets, 10-year yields varied meaningfully in response to the evolving news on both sides of the Atlantic; therefore, choosing where to take duration risk has been crucial. 

Exhibit 1: Core Rates Markets – 10-year yield change year-to-date

^{Source: Bloomberg. As at 23 April 2025. Reflects 10-year US Treasury yields (UST), UK Treasury yields (UKT) and German Bund yields (GER), year to date (31 December 2024 to 23 April 2025). Past performance does not predict future returns. All investments contain risk and may lose value.}

How has the breakdown of duration risk changed?

So far this year investors could have made the following changes:

• Added duration risk in Canada and Australia
• Actively managed risk in US and Europe
• Maintained exposure in UK, New Zealand and Italy 

Looking at the differing fortunes of 10-year US Treasurys versus 10-year German Bunds highlights the impact of market selection. During the opening months of 2025, 10-year US Treasury yields had been up to 57 basis points (bps) lower, while 10-year German Bunds were 53 bps higher in early March  (Exhibits 1 and 2).  

Exhibit 2: 10-year US Treasury vs 10-year German Bunds 

^{Source: Bloomberg. As at 23 April 2025. Reflects 10-year US Treasury yields vs German Bund yields, 1 July 2024 to 23 April 2025. Past performance does not predict future returns. All investments contain risk and may lose value.}

As these market choices are usually taken on a relative basis—buying one market, while selling another—the overall duration risk can often be unchanged as a result. By looking outside of the traditional markets (US, UK and Germany) into Australia, Canada, New Zealand, etc, there are opportunities for alpha generation and diversification.  

Yield curve positioning

One of the highest-conviction rates-market views in 2025 has been to position for steeper yield curves. Yield curves globally had been very flat, meaning that the yield investors are paid to own short-dated and long-dated bonds is almost the same. All else being equal, this favours allocations to shorter-dated bonds at the expense of longer-dated bonds.

So far in 2025, yield curves have changed shape for a variety of reasons. In the US, the prospect of stagflation due to more aggressive tariff measures has supported a steeper curve.  Stagflation—stagnant growth with higher inflation—supports this view as the “stag” part keeps short-dated yields in check, while the “flation” causes long-dated yields to rise.  From its year-to-date low in February, the US 5-year versus 30-year differential is almost 50 bps higher as of 23 April 2025.

Exhibit 3 and Exhibit 4: Year-to-date Yield Curve Change 
 

^{Source: Bloomberg. As at 23 April 2025 and 31 December 2024. Reflects 2-year, 3-year, 5-year, 7-year, 10-year, 20-year and 30-year US yield curve (Exhibit 3) and German yield curve (Exhibit 4), year to date (31 December 2024 to 23 April 2025). Past performance does not predict future returns. All investments contain risk and may lose value.}

In Germany, the steepening bias is equally as strong but with different drivers. Here, the anticipated increase in bond supply to fund that country’s massive fiscal spending plans, alongside the growing headwinds to growth from US trade tariffs, has seen short-dated bonds outperform. Similar to in the US, a short in 30-year Germany futures while holding shorter-dated assets - since year-end, the curve is 40 bps higher. We believe these curve moves will continue in the coming months.

Be active, be flexible and be creative

Duration risk should not be viewed as a blunt tool. Through the combination of overall risk, market selection and curve positioning, it can be a valuable source of alpha and one that is not just about whether government bond yields are going up or down. The current, uncertain environment requires investors to know what they’re buying and why—duration risk is no different. By casting the net wider and looking globally, the opportunity set is greater while also offering a more diversified set of risks. Importantly, many of the relative value opportunities available can add value with little additional overall risk.