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Adjustment to Duration (Interest Rate) Exposure

For our Core Portfolio clients, we are lowering exposure to interest rate risk. The term duration is used to measure how much risk an investor has relative to movements in interest rates. It is expressed in years. The more years of duration you have, the more risk you are carrying. Interest rates and bond prices move inversely to each other, so when interest rates go higher (lower) bond prices go lower (higher). We currently are holding a longer duration in our Core Portfolios to take advantage of the positively sloped yield curve. The yield on the 10 Year Treasury has consistently been 2%-3% higher than the yield on cash and the risk of duration was worth the extra payout.

The Fed has raised short-term rates 7 times and 1.75% over the last year and a half. For the first time in over a decade, the spread between the 10 Year Treasury and Cash yield has fallen below 1%. In our naïve forecasting process this means we expect to make less than 1% more by owning a 10 Year Treasury instead of cash. We don’t believe the reward of holding a longer duration still warrants the extra risk, therefore, at month end we will be moving “down” the yield curve and lessen our duration exposure in the Core Portfolios. Each Core Portfolio will be exchanging the IEF exchange traded fund for the IEI exchange traded fund. IEF is a 7-10 year maturity and IEI is a 3-7 year maturity. IEI has about 3 years less duration than IEF.

Specifically, the Conservative Portfolio will move from 3.0 years of duration to 2.5 years. The Moderate Portfolio will move from 2.0 years to 1.5 years, and the Aggressive Portfolio will move from 1.0 year to .7 year of duration. It may appear odd that the Aggressive Portfolio has less duration risk than the Conservative and Moderate Portfolios, but this is due to the stock-bond mix of each portfolio. The majority of risk in the Aggressive Portfolio is in stocks, therefore it has less interest rate risk in the overall risk measure. Since the Conservative Portfolio is designed to have less stock risk, the majority of risk is in bonds (interest rate exposure). It can all get a little confusing but in summary;

Given higher short-term rates and lower long-term rates, coupled with our view of a strengthening economy and slightly rising interest rates, we want less interest rate exposure in the portfolios. As always, please call us with any questions.

Have a great Labor Day Weekend,

The GreenPort Team

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