November 26, 2014: Bond Duration as Leverage

The 30 year Treasury is a powerful tool because small movements in interest rates cause big fluctuations in the price of the bond. As I will illustrate in this post, the magnified exposure acts as a form of leverage. And by using risk parity principles you can use this magnification to lever/delever an entire portfolio. This is important because it allows you to first decide on your risk allocation, and later dial in the risk level. This is a complicated subject, but hopefully the charts will help and please feel free to follow up in the comments section!

 Thanks to the ETF revolution, investors can very easily target different bond durations. The table below shows the bond ETFs for consideration in this analysis with their respective duration
  • EDV: 24.8
  • TLT: 17.2
  • TLH: 9.6
  • IEF: 7.6
  • IEI: 4.5

The graph below shows the performance of each product. I have represented the longer duration bonds with darker shades. As you can see, the products are all highly correlated but the duration affects the magnitude of the movements.

Stepping back, remember that the cashless Permanent Portfolio is an equal split between 30 year Treasuries (TLT), US Stocks, and Gold. The allocation works because the three asset classes have roughly equivalent volatility, making the portfolio a risk parity solution. Balancing risk between the asset classes is attractive because it protects your portfolio from macro shocks. 

However, what if you appreciate this balance but want to take more or less risk while remaining balanced across the asset classes? The logic is simple, the stronger the bond the less of it you need to get the target exposure.
By using different bond durations and weightings you can implicitly lever / delever your portfolio. The following table shows allocations I created that take into account the relative volatility of the bonds compared with stocks and gold.

Although the dollar weightings might appear to offer different exposures, the risk allocation across the portfolios is almost identical. Essentially, the portfolios only differ by the amount leverage applied to them. The charts below illustrate that the principles of risk parity are preserved, while offering different degrees of magnification. This is verified quantitatively by looking at the correlation matrix.

In summary , risk parity strategies don’t have to be one size fits all allocations. You can dial in your risk level by using leverage, and the best leverage available to retail investors can be found on the other side of the bond desk. 


  1. Ryan...thanks for this post. How would this be report be impacted using:
    (a) 30 year bonds held directly, rolled over to fresh bonds at 20 years (standard) HBPP plan)
    (b) 30 year bonds held directly, rolled over annually (say held in an IRA)

    Implicit in my question is if a 30 year bond today with over 29 years to maturity has similar volatility/duration to EDV?

    Finally, when I chart EDV going back to Dec 2008, the price hit its all time high. Your charts are based on re-invested dividends?

  2. Hi murphy,

    Unfortunately I don't have a great way to backtest those impacts. However, I think the ETFs do a good job of tracking the underlying securities.

    Yes, my charts assume all dividends /interest get reinvested into the respective security.