Forward Curve Shifts and Return Convergence

Abstract

Most investment-grade bond portfolios have a relatively stable duration that shapes their multiyear returns. These returns are impacted by the wide variety of yield paths that can result from sequential migrations to implied forward yield curves, accompanied by parallel trend line shifts. Under these theoretical conditions, the annualized return converges, over an investment horizon that is roughly twice the portfolio’s duration, toward a starting yield curve value whose maturity just coincides with this specific horizon. Thus, a stable duration portfolio return will converge, with surprisingly minimal dispersions, back to a yield curve value that prevailed at the outset—regardless of the direction or volatility of intervening yields. These results have important implications for multiyear return estimation and for volatility assumptions involved in asset allocation.