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How to manage Volatility in Bonds?

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Investors who've been fleeing jittery stocks and hiding out in the fixed-income market face a new quandary: finding something to ballast their bonds, which have experienced their own spike in volatility of late.


The Merrill Lynch MOVE Index, which measures bond market volatility by gauging options contracts on Treasury issues, jumped from a below-average reading of 57 in early May to an above-average 95 on June 15. The index has since fallen back, but the wild swings in certain segments of the market are undeniable.


Consider the stomach churning performance of long-dated Treasurys. They surged 11% late last year, sank 9% from mid-December to mid-March, and have soared 14% since then.


In Europe, government bonds have been just as bumpy, but unlike Treasurys they've lost considerable value in recent months. The iShares S&P/Citigroup International Treasury Bond Fund, with big stakes in European sovereign debt, has sunk nearly 8% since last fall, as interest rates have risen amid concerns about fiscal health in the eurozone.



As fears surrounding Europe's debt crisis have grown, money has been racing out of the region and pouring into comparatively safe Treasurys, where yields on 10-year notes have sunk to just 1.65% from 2.38% in mid-March.


While falling energy prices are typically good for the economy, many market strategists see today's rapidly slumping oil prices as a sign of how sluggish the global economy has become, raising questions about the safety of sovereign debt.


Chris Vincent, head of the fixed-income group at asset management firm William Blair, said it was likely that this volatility would persist for some time, as the world slowly worked its way through a classic debt deflation cycle. To be sure, not all parts of the fixed-income market appear as risky as Treasury and foreign debt. A diversified core bond portfolio that tracks the Barclays aggregate bond index is likely to be split among Treasuries, mortgage-backed and government agency debt, and investment-grade corporate bonds. And he points out that high-grade corporate and government agency bonds have performed reasonably well recently while being relatively stable.

According to Morningstar, for instance, mortgage and agency bond funds have a standard deviation – a gauge of volatility – of 2.3 over the last three years.


By comparison, the average standard deviation is 3.7 for intermediate- and long-term corporate bond funds and 9.7 for Treasuries. 

 

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