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Why duration matters in fixed income investing
Neil Mehta, Portfolio Manager for Investment Grade at RBC BlueBay, looks at the factors to consider when adding duration to fixed income portfolios.
Holding duration – interest rate risk – makes sense from several angles when investing in bond markets: managing turning points in interest rate cycles, delivering income and carry, providing asset diversification, and protection as a recession hedge. The question confronting investors is not whether to include bonds in their portfolios, but how much to hold and in what form to express that exposure. Investors need to be selective, and therefore ask: where on the yield curve does duration offer the best risk/return? Which regions and countries offer the best carry and income?
The immediate case for duration is directional
Where central banks approach or reach the peak of their monetary tightening cycle, bonds will deliver superior returns from a duration perspective. Two regions that stand out from this perspective are the UK and Japan, where we think disinflationary forces will bring out a more dovish reaction function from the BoE and BoJ respectively, relative to current market expectations.
Disinflation is taking hold in the UK, as the labour market loosens and energy prices fall from elevated levels. Moreover, we think key MPC members will ‘not welcome unemployment’ and we expect the BoE to ease three times in 2026. This should provide a tailwind for gilt returns.
Moreover, the BoJ is still embarking on a hiking cycle, with the market pricing another 0.5% increase in policy rates to end-2026. This has seen 10-year JGBs trade above a yield of 2%, levels not seen since 1998. However, we think inflation is levelling off and the new government will be keen to allay concerns on food prices such as rice. Long end JGBs will provide an attractive return at this juncture, having sold off aggressively.
It is also worth noting real yields in both markets, and many developed markets for that matter remain positive, providing inflation protection.
On the income side, duration provides steady carry and roll down in selected markets
The post-pandemic era, fuelled by higher inflation premium embedded in bonds, is a throwback to the pre-GFC time, where curves are steeper and 10-year bond yields in the US and Europe are above 4% and 2.5%, respectively. Moreover, we would argue that yield curves are still too flat versus historical cycle points and will continue to provide improved carry dynamics.
Ironically, the benefits of duration are best exhibited in the onset of a recession or in recessionary conditions
We think bonds remains the primary hedge for risk-off and recessionary scenarios. As central banks thread the soft-landing needle, geopolitical risks remain high, and valuations in many asset markets are stretched with tight spreads and high P/E ratios. The threat of credit dislocations is on the up. Bonds can be the anchor should things turn south quickly. A black swan event duration provides insurance, and duration has typically outperformed aggressively in that environment. This can be showcased in a simple scenario. The table below shows the bond's resilience to moderate moves in yield while capturing significant upside in rallying scenarios. The table also captures the power of convexity, where certain long-dated bonds carry positive convexity, meaning investor gains accelerate as yields fall and losses decelerate as yields rise relative to a linear instrument. Convexity has value, particularly in volatile rate environment.
Simple scenario – holding period 1 year for a 3% coupon 10-year bond, 8 years duration, assuming a 2% repo rate
Source: RBC GAM, as at February 2026.
RBC BlueBay and duration
Understanding how markets move on the back of policy and political shifts – and how these may influence the direction of interest rates – is key to our competitive edge at RBC BlueBay, With an uncertain macro backdrop set to remain, duration remains a versatile and critical tool for our team when investing across the dynamic and evolving fixed income landscape.
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