Why the Kailash Equity Duration Tool is a Must Have for Managers
This paper extends on our last piece, The Great Inflation. Our research indicates investors and asset allocators face a “duration crisis.” This paper seeks to hammer home:
- Equities in aggregate have high sensitivity to rates based on history
- The aggregate duration is heavily skewed by a group of outliers
- There are still a large number of low duration equities that can help mitigate duration risk for Asset Allocators, Portfolio Managers and Investors
Kailash has spent months working to build a tool to provide credible estimates of equity durations. For a walk-through on the academic underpinnings and the numerous modifications Kailash employed to calculate Equity Duration, please click here. Kailash believes certain equities can help manage duration risk while providing a valuable inflation hedge.
Figure 1 below shows the equity duration for the S&P 500. Using a constant 6% discount rate over history, the broad S&P 500 Index now has an equity duration of 40 years. The prior all-time high was at the very peak of the internet bubble when the Index duration hit 43 years.
While Kailash’s proprietary equity duration tool estimates any given security’s sensitivity to interest rate shocks, we find the index figures to highlight the risks of traditional asset allocation strategies. Kailash first wrote about the dangers in our piece 60/40 Asset Allocation: Buying a Ticket on the Titanic based on the common-sense observation that bonds, at current yields, offer negligible income and enormous risks. With this new tool, Kailash can now create approximate calculations for any set of US equity funds and bond funds.
IN 2000, THE LAST TIME EQUITY DURATIONS HIT 40 YEARS, 5 YEAR TREASURY BONDS YIELDED 6%, TODAY THEY YIELD 1.5%. Today’s same mix of assets provides a very different risk/return profile than the one suggested by many backwards-looking asset allocation models. To see how different discount rates impact aggregate equity duration, click here.