Protection with the Zero-duration share class

Protection with the Zero-duration share class

11-07-2013 | Insight

Long-term interest rates are more likely to rise than fall. This makes it particularly interesting to invest in the Robeco Zero-duration share class, because bond prices react inversely to yields.

How can corporate-bond investors protect themselves against a possible rise in long-term interest rates?

Zero duration lowers interest-rate sensitivity. The Robeco Zero-duration share class is created using interest-rate swaps.

  • Yields on US and European government bonds rose after reports that the Fed could begin tapering back its bond purchases;
  • Robeco offers a Zero-duration variant that protects the regular share class against a rise in the long-term interest rates;
  • Some peers in the market offer so-called short-duration funds, but these have serious drawbacks versus our Zero-Duration offering:
  • Robeco offers Zero-duration variants for High Yield Bonds, Investment Grade Corporate Bonds and Financial Institutions Bonds.

Yields rise after Fed policy statements

Yields on US and European government bonds rose after reports that the Fed could begin tapering back its bond purchases later this year if the US economy keeps improving. Figure 1 shows the 5-year German Government Bonds and US Treasury yields (in %).

Currently, the Fed is buying USD 85 billion each month in treasury paper and mortgage-backed securities to stimulate economic and jobs growth. Bond investors expect this to be the starting point of a Fed policy that is less accommodating to the bond market. They fear that the Fed might raise short-term interest rates after 2015 in order to fight inflation.

In the euro zone, the situation is different: the ECB has pledged that interest rates will remain at record lows far into the future. The euro-zone economy is still weak.

Figure 1: 5-year German Government Bonds and US Treasury yields (in %)
Source: Bloomberg

Zero-duration share class - how does it work?

Robeco offers a Zero-duration variant that protects the regular share class against a rise in the long-term interest rates, while investors can still try to take advantage of higher credit spreads.

The Zero-duration share class invests in the existing portfolio and includes an interest-rate hedge. This hedge lowers interest-rate sensitivity by swapping the 5-year interest rate for the money-market rate (Libor 3 months). This means that Robeco pays the fixed interest rate while receiving the floating interest rate. The result is a lower sensitivity to interest rates. The investor can still benefit from potential credit-spread tightening. The expected returns on high-yield bonds are twofold: the credit spread and the interest rate. The swap makes the interest-rate component variable. When government bond yields rise, the Zero-duration share class is expected to outperform the regular share class.

Implementing this hedge lowers the yield of the portfolio. This difference currently amounts to about 1.5%. As the current duration of the Robeco High Yield fund is around 4.4 years, the interest rates only have to rise by about 35bps in order to break-even between both share classes (duration x rate increase) and to compensate for this yield give-up. In a scenario of stronger rate increases, the Zero-duration share class is expected to deliver higher total returns than the regular share class.

Case study: investing in Robeco High Yield

High-yield bonds offer investors attractive credit spreads: the current US high yield credit spread is 480 bp on government bonds. Figure 2 shows the US high yield credit spread since 1994. But what is the best way to reap the benefits of this credit spread, when long-term interest rates can have a major impact on total returns?

Robeco High Yield Zero Duration offers protection against a further rise in long-term interest rates by exchanging the 5-year swap rate for the 3-months swap rate.

The cumulative performance difference (in %) between the zero and regular high-yield share class is shown in Figure 3 (red line) together with the development of the 5-year swap rate (blue line). They can be seen to have moved more or less in line. The performance of the Robeco High Yield Zero-duration share class versus the regular class can also be seen in Figure 3. The Zero-duration class outperformed the regular share class in recent weeks as a result of increasing interest rates.

The return on a high yield bond corresponds to a yield on a comparable government bond plus a credit spread (higher interest rate) to compensate for the risk associated with a high-yield investment.

The regular Robeco High Yield share class offers a yield of 6.4%, consisting of a long-term interest rate of 1.7% and a credit spread of 4.7%. The sensitivity of the interest rate and of the credit spread is 4-5 years.

The Robeco Zero-Duration share class offers a yield of 4.9%, consisting of a short-term interest rate of 0.2% and a credit spread that is also 4.7%. The sensitivity of the interest rate component is reduced to around zero, while the sensitivity of the credit spread is around five years.

The Robeco High Yield fund manager expects returns in line with yields for the next twelve months of around 6.4% (as per end of June 2013. Following the recent yield increase, he has been adding slightly more risk to the portfolio by adding some bonds that repriced disproportionately. The credit beta of the fund has been increased from underweight to neutral (beta is 1). In the US, there have been outflows in high-yield ETF holdings, represented by predominantly tactical investors. This has been much less the case with actively managed funds like Robeco’s High Yield fund.

The fund manager believes that the search for yield is not over yet, and that investors might add risk to their portfolios once the markets stabilize somewhat. On the back of the relatively weak economy, it remains key to focus within the high-yield universe on the strongest companies able to weather the storm. Robeco High Yield therefore avoids the weakest issuers.

Figure 2: US high-yield credit spreads from January 1994 (in %)
Source: Barclays

Figure 3: Cumulative performance difference (in %) between Robeco High Yield Zero Duration (0DH) and regular Robeco High Yield (DH) and performance of 5-year swaps (in %)
Source: Robeco

Short-duration fund alternatives have drawbacks Some peers in the market offer so-called short-duration funds. These funds are invested in bonds with short maturities only. These alternative funds have serious drawbacks versus our Zero-Duration offering:

  • Investable universe is limited. A short-dated bond fund has a smaller investable universe, because it cannot use all maturities. This makes it more difficult to build a well-diversified portfolio. On the other hand, Robeco’s portfolio manager can select long-duration bonds if they are attractively priced. This increases the opportunity for alpha generation.
  • Illiquidity. Short-dated bonds tend to be subject to less liquid trading. This can lead to higher trading costs.
  • Higher call risk. This risk (i.e. that a bond issuer will take advantage of the callable bond feature and redeem the issue prior to maturity) is more prominent in bonds with shorter maturities. The higher call risk leads to an uncertain risk/return profile and interest-rate sensitivity.
  • Lower yields. Short-duration bond funds offer considerably lower yields on the portfolio compared to the Robeco Zero-duration share classes.

A switch from the regular share class to the zero-duration share class is easily done without any buying or selling of bonds, simply by trading in the interest-rate swap, a highly traded financial instrument.

The Zero-duration strategy is implemented by state-of-the-art systems with a strong focus on operational and financial risk management. Robeco’s risk-management system includes the use of derivatives, and risk is measured on a daily basis.

Robeco offers Zero-duration variants for High Yield Bonds, Investment Grade Corporate Bonds and Financial Institutions Bonds. Robeco can also offer tailor-made solutions to decrease duration.

Interested in what the Zero-duration share class can do for you? Please contact your account manager to check availability.

For professional investors only. The value of your investment may fluctuate. Past performance is no guarantee of future results.

Read also: Zero duration to protect against rising yields

Important information

The contents of this document have not been reviewed by the Securities and Futures Commission ("SFC") in Hong Kong. If you are in any doubt about any of the contents of this document, you should obtain independent professional advice. This document has been distributed by Robeco Hong Kong Limited (‘Robeco’). Robeco is regulated by the SFC in Hong Kong.
This document has been prepared on a confidential basis solely for the recipient and is for information purposes only. Any reproduction or distribution of this documentation, in whole or in part, or the disclosure of its contents, without the prior written consent of Robeco, is prohibited. By accepting this documentation, the recipient agrees to the foregoing
This document is intended to provide the reader with information on Robeco’s specific capabilities, but does not constitute a recommendation to buy or sell certain securities or investment products. Investment decisions should only be based on the relevant prospectus and on thorough financial, fiscal and legal advice. Please refer to the relevant offering documents for details including the risk factors before making any investment decisions.
The contents of this document are based upon sources of information believed to be reliable. This document is not intended for distribution to or use by any person or entity in any jurisdiction or country where such distribution or use would be contrary to local law or regulation.
Investment Involves risks. Historical returns are provided for illustrative purposes only and do not necessarily reflect Robeco’s expectations for the future. The value of your investments may fluctuate. Past performance is no indication of current or future performance.

Subjects related to this article are:


1. General
Please read this information carefully.

This website is prepared and issued by Robeco Hong Kong Limited ("Robeco"), which is a corporation licensed by the Securities and Futures Commission in Hong Kong to engage in Type 1 (dealing in securities); Type 4 (advising in securities) and Type 9 (asset management) regulated activities. This website has not been reviewed by the Securities and Futures Commission or any regulatory authority in Hong Kong.

2. Important risk disclosures
2. Important risk disclosures Robeco Capital Growth Funds (“the Funds”) are distinguished by their respective specific investment policies or any other specific features. Please read carefully for the risks of the Funds:

  • Some Funds are subject to investment, market, equities, liquidity, counterparty, securities lending and foreign currency risk and risk associated with investments in small and/or mid-capped companies.
  • Some Funds are subject to the risks of investing in emerging markets which include political, economic, legal, regulatory, market, settlement, execution, counterparty and currency risks.
  • Some Funds may invest in China A shares directly through the Qualified Foreign Institutional Investor (“QFII”) scheme and / or RMB Qualified Foreign Institutional Investor (“RQFII”) scheme and / or Stock Connect programmes which may entail additional clearing and settlement, regulatory, operational, counterparty and liquidity risk.
  • For distributing share classes, some Funds may pay out dividend distributions out of capital. Where distributions are paid out of capital, this amounts to a return or withdrawal of part of your original investment or capital gains attributable to that and may result in an immediate decrease in the net asset value of shares.
  • Some Funds’ investments maybe concentrated in one region / one country / one sector / around one theme and therefore the value of the Fund may be more volatile and may be subject to concentration risk.
  • The risk exists that the quantitative techniques used by some Funds may not work and the Funds’ value may be adversely affected.
  • In addition to investment, market, liquidity, counterparty, securities lending, (reverse) repurchase agreements and foreign currency risk, some Funds are subject to risk associated with fixed income investments like credit risk, interest rate risk, convertible bonds risk, ABS risk and the risk of investments in non-investment grade or unrated securities and the risk of investments made in non-investment grade sovereign securities.
  • Some Funds can use derivatives extensively. Robeco Global Consumer Trends Equities can use derivatives for hedging and efficient portfolio management. Derivatives exposure may involve higher counterparty, liquidity and valuation risks. In adverse situations, the Funds may suffer significant losses (even a total loss of the Funds’ assets) from its derivative usage.
  • Robeco European High Yield Bonds is subject to Eurozone risk.
  • Investors may suffer substantial losses of their investments in the Funds. Investor should not invest in the Funds solely based on the information provided in this document and should read the offering documents (including potential risks involved) for details.

3. Local legal and sales restrictions
The Website is to be accessed by “professional investors” only (as defined in the Securities and Futures Ordinance (Cap.571) and/or the Securities and Futures (Professional Investors) Rules (Cap.571D) under the laws of Hong Kong). The Website is not directed at any person in any jurisdiction where (by reason of that person’s nationality, residence or otherwise) the publication or availability of the Website is prohibited. Persons in respect of whom such prohibitions apply or persons other than those specified above must not access this Website. Persons accessing the Website need to be aware that they are responsible themselves for the compliance with all local rules and regulations. By accessing this Website and any of its pages, you acknowledge your agreement with understanding of the following terms of use and legal information. If you do not agree to the terms and conditions below, do not access this Website or any pages thereof.

The information contained in the Website is being provided for information purposes.

Neither information nor any opinion expressed on the Website constitutes a solicitation, an offer or a recommendation to buy, sell or dispose of any investment, to engage in any other transaction or to provide any investment advice or service. The information contained in the Website does not constitute investment advice or a recommendation and was prepared without regard to the specific objectives, financial situation or needs of any particular person who may receive it. An investment in a Robeco product should only be made after reading the related legal documents such as management regulations, prospectuses, most recent annual and semi-annual reports, which can be all be obtained free of charge at www.robeco.com/hk/en and at the Robeco Hong Kong office.

4. Use of the Website
The information is based on certain assumptions, information and conditions applicable at a certain time and may be subject to change at any time without notice. Robeco aims to provide accurate, complete and up-to-date information, obtained from sources of information believed to be reliable. Persons accessing the Website are responsible for their choice and use of the information.

5. Investment performance
No assurance can be given that the investment objective of any investment products will be achieved. No representation or promise as to the performance of any investment products or the return on an investment is made. The value of your investments may fluctuate. The value of the assets of Robeco investment products may also fluctuate as a result of the investment policy and/or the developments on the financial markets. Results obtained in the past are no guarantee for the future. Past performance, projection, or forecast included in this Website should not be taken as an indication or guarantee of future performance, and no representation or warranty, express or implied, is made regarding future performance. Fund performance figures are based on the month-end trading prices and are calculated on a total return basis with dividends reinvested. Return figures versus the benchmark show the investment management result before management and/or performance fees; the fund returns are with dividends reinvested and based on net asset values with prices and exchange rates of the valuation moment of the benchmark.
Investments involve risks. Past performance is not a guide to future performance. Potential investors should read the terms and conditions contained in the relevant offering documents and in particular the investment policies and the risk factors before any investment decision is made. Investors should ensure they fully understand the risks associated with the fund and should also consider their own investment objective and risk tolerance level. Investors are reminded that the value and income (if any) from shares of the fund may be volatile and could change substantially within a short period of time, and investors may not get back the amount they have invested in the fund. If in doubt, please seek independent financial and professional advice.

6. Third party websites
Following links to any other off-site pages or websites of third parties shall be at the own risk of the person following such link. Robeco has not reviewed any of the websites linked to or referred to by the Website and does not endorse or accept any responsibility for their content nor the products, services or other items offered through them. Robeco shall have no liability for any losses or damages arising from the use of or reliance on the information contained on websites of third parties, including, without limitation, any loss of profit or any other direct or indirect damage.

7. Limitation of liability
Robeco as well as (possible) other suppliers of information to the Website accept no responsibility for the contents of the Website or the information or recommendations contained herein, which moreover may be changed without notice.
Robeco assumes no responsibility for ensuring, and makes no warranty, that the functioning of the Website will be uninterrupted or error-free. Robeco assumes no responsibility for the consequences of e-mail messages regarding a Robeco (transaction) service, which either cannot be received or sent, are damaged, received or sent incorrectly, or not received or sent on time.
Neither will Robeco be liable for any loss or damage that may result from access to and use of the Website.

8. Intellectual property
All copyrights, patents, intellectual and other property, and licenses regarding the information on the Website are held and obtained by Robeco. These rights will not be passed to persons accessing this information.

9. Privacy
Robeco guarantees that the data of persons accessing the Website will be treated confidentially in accordance with prevailing data protection regulations. Such data will not be made available to third parties without the approval of the persons accessing the Website, unless Robeco is legally obliged to do so. Please find more details in our Privacy and Cookie Policy.

10. Applicable law
The Website shall be governed by and construed in accordance with the laws of Hong Kong. All disputes arising out of or in connection with the Website shall be submitted to the exclusive jurisdiction of the courts of Hong Kong. 

Please click “I agree” button if you have read and understood this page and agree to the Disclaimers above and the collection and use of your personal data by Robeco, for the purposes for which such data is collected and used as set out in the Privacy and Cookie Policy, including for the purpose of direct marketing of Robeco products or services. Otherwise, please click “I Disagree” to leave the website.

I Disagree