Maturity-Matched Bond Fund Performance
37 Pages Posted: 2 Dec 2016 Last revised: 8 Jul 2020
Date Written: July 8, 2020
We discover systematic maturity-mismatch errors in bond fund alphas, which originate from using linear regressions despite the known nonlinearity between interest rate risk and expected returns. During our sample period, this has led on average to an overestimation of performance.
We also show that popular fund ratings and investor flows are influenced by this error. Our simple and practical remedy for the problem is to individually match funds and indices using their durations, thereby immunizing alpha to interest rate changes. If the fund’s duration is unknown, we identify beta and R2 as candidates for alternative matchings.
Keywords: Bond funds, performance, maturity mismatch, yield curve, interest rate risk
JEL Classification: G20, G11, G23
Suggested Citation: Suggested Citation