Bond ` Duration ' Stirs a Bit of Controversy
By Jacqueline M. Doherty

01/02/1996 The Wall Street Journal Page 37

This is a story about bond duration.

Don't put down the newspaper.

You can hardly avoid the dreaded word anymore if you venture into the fixed-income realm. Some mutual funds are even renaming themselves to emphasize duration. That's what happened to the PaineWebber Short-Term U.S. Government Income Fund; it chose a new monicker and became the PaineWebber Low Duration U.S. Government Income Fund.

Must you really understand duration to be a savvy investor? Well, it can't hurt, but other factors affecting your bond fund are definitely just as important. So why are the mutual-fund companies suddenly obsessed with slinging around this term?

It's "a marketing tool," says Barry Evans, a portfolio manager with John Hancock Funds, which doesn't use duration in fund titles or prospectuses.

"Duration is a way to say `safe' or `stable' without saying those words," according to Ralph Norton, managing editor and vice president of IBC/Donoghue Inc., an Ashland, Mass., publisher of mutual-fund newsletters.

"People are using the word duration as a code word for low risk," says A. Michael Lipper, president of Lipper Analytical Services Inc. That's why you won't find any Long Duration MegaRisk funds out there, or any High Duration Shoot-the-Moon Holdings.

Yet even some funds that are short on duration aren't free of risk, Mr. Lipper and other fund watchers warn.

Duration isn't the same as maturity, the time span until a bond comes due. Duration is a different, and bond-market pros say a better, way to measure interest-rate risk. In essence, the higher a bond fund's duration, the more steeply its share price will plunge when interest rates rise -- or rally when rates fall.

Forget the complex math used to figure duration: there's an easy way investors can use it. To get a rough idea of the potential impact of a one-percentage-point swing in interest rates on your bond fund, you can do an easy bit of multiplication. If a fund's duration is 5.2 years, then if interest rates rise by one percentage point the bond fund's price should drop about 5.2%.

To find out a fund's duration, try the fund's toll-free 800 phone number. As a rule of thumb, funds with durations of one to three years are relatively conservative. There's moderate interest-rate risk in durations of three to seven years, still more risk beyond seven years.

Isn't the average maturity enough to know? It helps. But remember what happened in the 1994 bond debacle. A number of supposedly safe, short-maturity bond funds got clobbered by rising rates. Many were holding some exotic securities such as inverse floaters and mortgages, which can have short maturities but long durations.

"Shareholders got upset when the duration of a portfolio didn't match its average weighted maturity," says Robert Plaze, assistant director at the Securities and Exchange Commission's Division of Investment Management.

Since then, more funds have begun using the word duration in their names, and placing duration limits in prospectuses. But some people think too much emphasis is being put on duration, lulling investors into a false sense of comfort. Even low-duration bond funds aren't money-market funds. When interest rates drop, the value of short-duration bond funds can drop too. And duration doesn't address other types of risk such as currency risk, or the possibility that a junk-bond issuer won't make interest payments. Duration can be highly unpredictable for some investments such as mortgage securities, which are affected by early repayment of the underlying mortgage loans.

Duration has its defenders. "`Short-term' has the potential to mislead investors that it's a money-market fund," argues Dennis McCauley, chief investment officer of PaineWebber Inc.'s Mitchell Hutchins Asset Management Inc. In the case of PaineWebber's renamed fund, "the title is much clearer than it was." And while the fund formerly was required to have an average maturity of one to three years, it now must have a duration of one to three years.

Still puzzled? There may be good news from Washington one of these days. The SEC is considering adding a duration test to funds that categorize themselves as short-term or intermediate-term, says Mr. Plaze. Bond funds may be required to have durations that reflect the interest-rate risk implied in the fund's name or investment objective. The SEC has asked the Investment Company Institute, a leading mutual-fund trade group, to define a method for calculating duration.

So don't let duration get you down. "Understanding the mathematics is useless," says IBC's Mr. Norton. "Knowing that high duration means higher interest-rate-sensitivity is all you need to know."