Understanding ‘Duration Management’
of Debt Papers
– By Prof. Simply Simple TM
We have an idea about
management of equity funds.
Equity Funds are managed by:
1. Identifying stocks based on research.
2. Understanding the macro-economic
3. Selecting the right stocks.
A good fund manager does that. &
when he does that well, investors stand
to make good gains.
If this is how equity funds are
managed, then how are debt
While, on one hand, debt
funds invest in debt papers
which need to give good fixed
returns & be of good quality
there is another aspect which
is very crucial in debt fund
And that is ‘Duration
Management’ of the debt
Based on the interest rate
outlook, the fund manager
decides whether he should invest
in long duration papers maturing
over a period of, say, 10 years or
short duration papers maturing
over a period of, say, 6 months.
But how is his decision of selecting
long duration papers or short
duration papers connected with the
interest rate outlook?
Simply speaking, when interest
rates are expected to go up, the
debt fund manager would invest
in shorter duration papers but if
interest rates are expected to
come down, then he would do
the opposite and invest in longer
This is how the story usually
ends & people remember this
like they would remember any
This is where there is a need to
uncover the concept of
And what better than taking
‘cricket’ as an example?
When we think of cricket, the ‘IPL’
comes to our minds in a flash.
So what has the IPL achieved?
At one level, it has strengthened the
bench strength of the Indian cricket.
Today, for example, we have enough
fast bowlers, spinners, batsmen etc.
Imagine when we went for the
recently concluded T-20 World Cup,
we had to leave behind Pragyan
Ojha, who was the highest wicket
taker of the IPL.
So what does this bench strength
mean for the BCCI?
At one level, it means that there
are enough players available.
Hence if the BCCI needs a
replacement, they would be
It also means that BCCI will not want to
sign long term contracts with players.
Long term contracts mean long term
commitments & with a strong bench
strength, there is no need for the BCCI
to enter into any long term
commitments with any player as they
have the choice of dipping into the
bench whenever current players lose
Similarly when the fund
manager thinks that the
interest rates are likely to go
up in the near future, it
means that debt papers in
the future will offer better
rates of return for the
So just like a strong bench strength
offered options for BCCI driving them
to enter into short term contracts with
players, similarly the fund manager
observes that since interest rates are
likely to rise soon and that debt papers
giving a higher interest rates would
become available he too would invest
in papers with shorter maturities so
that by the time the interest rates rise,
his papers have matured and he has
cash to invest in the new papers.
Now what happens when the debt
fund manager believes that interest
rates is more likely to come down?
He just reverses his strategy and
invests in long duration papers.
Now how do we explain this?
Lets once again turn to cricket.
You will recollect that at one point in
time a couple of years back the
Australian cricket team saw Glenn
McGrath, Shane Warne, Mark Waugh,
Steve Waugh, Justin Langer all retiring
at more or less the same time.
Suddenly there was a dearth of players
and the bench strength dried up
In such a situation what do you think
the Aus. Cricket Board would could
They would typically get into long
term contracts with their players so
that they do not lose them to some
county or club. The board would thus
show more commitment. So even when
there is dearth of players the long term
contracts signed with the players
would stand the board in good stead.
In such a scenario, the value of the
player goes up due to the dearth of
players. So if some county would want
to grab a contracted player, they would
have to pay a large price to the
Australian Cricket Board for cancelling
In the same manner, if a debt fund
manager feels that interest rates are
coming down and that fresh papers in
the future would bear a lower interest
rates, he would naturally invest in
currently available papers for a longer
By doing so, his money stays invested
in higher interest bearing papers even
in a lower interest rate regime.
Just as the value of the cricket player
went up when there was a dearth of
players and the Cricket Board could
extract a price to walk out of the
contract, in the same manner the value
of the higher interest bearing papers
too would go up and the fund manager
too could extract a higher price by
selling it in the market!
Hope this lesson has given you
an idea of ‘Duration
Management’ of debt papers.
I will be glad to receive your feedback
on this lesson to understand if there
Your feedback will help me improve
my lessons going forward.
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other concepts, please write to me on
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The views expressed in these lessons are for information
purposes only and do not construe to be of any investment,
legal or taxation advice. They are not indicative of future
market trends, nor is Tata Asset Management Ltd. attempting
to predict the same. Reprinting any part of this presentation
will be at your own risk and Tata Asset Management Ltd. will
not be liable for the consequences of any such action.