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Investing in euro government bonds with limited interest risk

Investing in euro government bonds with limited interest risk

15-09-2015 | Insight

The Eurozone offers attractive opportunities for active bond investors. At the same time, more and more investors see a risk of interest rates rising in the not too distant future. The recently introduced 2-year duration share class of Robeco Euro Government Bonds substantially limits the interest rate risk, while fully benefiting from opportunities in the Eurozone’s country spreads and yield curve dynamics.

  • Olaf  Penninga
    Olaf
    Penninga
    Senior portfolio manager fixed income

Speed read

  • Euro Government Bonds now has a 2-year duration share class
  • Limiting interest rate risks substantially
  • While  benefiting fully from country and curve opportunities

For investors who want to protect themselves against the risk of rising interest rates, Robeco Euro Government Bonds recently introduced a 2-year duration share class. As this share class* is set up as a duration hedge overlay on top of the regular fund, it is able to offer the best of both worlds: a limited interest-rate risk profile and the ability to benefit from the full range of opportunities offered by the various country spreads and yield curves in the euro government bond markets.

The benchmark for this share class has a duration of two years. The portfolio manager will apply active duration management on top of this benchmark. The actual duration can therefore deviate from two years. On a structural basis, the duration of this share class will be approximately five years shorter than the regular share class.

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A 2-year duration limits interest rate risk

There were various considerations to choose a 2-year duration to offer protection against rising interest rates:

  • A 2-year duration share class fits in the short-term government bond funds market segment. These funds tend to have a benchmark with 1-3 year bonds and, as a result, a duration of approximately two years.
  • A positive duration allows for diversification benefits between interest rate risk and credit risk of countries.
  • A 2-year share class still offers opportunity for active duration management. Consequently, the duration can be lower than two years, if fund management thinks this is advisable.
  • Because of the negative correlation between country spreads and Bund yields, the portfolio’s effective duration will be lower than two years. The effective duration could become negative if the target duration of the share class were to be less than two years. We do not think this fits the risk profile of a government bond fund.

According to their own interest rate outlook, investors can move from the regular share class to the 2-year duration share class, without additional costs being charged. The 2-year duration share class of Robeco Euro Government Bonds has less interest rate risk than bond funds and a higher yield than money market funds.

Eurozone offers ample opportunities for active management

Robeco Euro Government Bonds aims to seize the opportunities that arise as the result of divergence between countries in the Eurozone. Our country allocation framework enables us to benefit from attractive yields as we continuously assess opportunities against their downside risks. In addition to country allocation, the fund actively manages interest rate risk, aiming to benefit from parallel shifts and twists of the yield curves.

As the European Central Bank is continuing its Quantitative Easing program, the search for yield continues. Fundamentals in the Eurozone are improving as growth appears to be taking off and necessary reforms are being implemented. Volatility in country spreads and yield curve dynamics are offering ample opportunities for active management. The two-year duration share class of Robeco Euro Government Bonds allows investors to benefit from these opportunities. With its low duration it offers a safer option in case interest rates should rise.

* 2CH, 2EH, 2FH, and 2IH.

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