Tipping point: What is modified duration?

This is a measure of how sensitive a debt fund is to a change in interest rates. If the modified duration is low, the net asset value (NAV) of the debt fund responds less to a change in interest rates, and vice versa.  

Why is this measure significant?
Some debt funds, like dynamic bond funds, have a lot of leeway regarding the level of duration risk they can take. Their fund managers try to raise the modified duration when they think that interest rates are going to fall and try to lower the modified duration when they think that rates are going to rise. If they get their timing right before rates change, their funds do well. But if they act after rates have changed, the performance of their fund lags. Among dynamic funds, by looking at the historic range of modified duration within which the fund manager has moved, you can tell which ones take more risk.



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