What duration measures
Duration is the measure of a bond's sensitivity to interest rate changes. Mathematically, it approximates the percentage change in price for a 1% (100 basis point) change in yield. A bond with a duration of 8 will lose approximately 8% of its price if yields rise 1%, and gain about 8% if yields fall 1%.
Modified duration is the most commonly used form. Macaulay duration is the weighted average time to receive the bond's cash flows and is the theoretical foundation. For convex bonds (most standard bonds), duration understates the price gain from falling yields and overstates the loss from rising yields — this convexity is a feature bonds have that benefits holders.
Long-duration bonds (10-30 year maturities) have much higher duration than short-duration bonds. TLT (20+ year Treasuries) has a duration of roughly 16-18 years. A 1% yield rise causes roughly a 16-18% price drop in TLT. This is why long-duration bonds behave almost like leveraged rate bets.
Portfolio managers use duration to measure and manage their interest rate risk. A portfolio with average duration of 5 will lose approximately 5% of value if rates rise 1%. This sensitivity is why rising-rate environments are problematic for bond-heavy portfolios and why 2022, with the fastest hiking cycle in 40 years, was the worst bond bear market in modern history.
Duration and equity
Equity stocks have "duration" in a loose sense — their valuations reflect the present value of future cash flows. Growth stocks with earnings weighted far into the future have high implicit duration. Value stocks with current earnings have lower duration.
This is why growth stocks underperformed dramatically in 2022 when rates rose sharply. The 4-5% rise in the 10-year yield functioned like a severe "duration shock" on high-multiple growth names — their valuations were crushed by the increased discount rate even if the underlying businesses were healthy.
The relationship reverses when rates fall (or the market expects rates to fall). Growth stocks with high implicit duration are the biggest beneficiaries of falling rate expectations. This is why rate cut cycles have historically produced the strongest rallies in growth and technology sectors.
Managing duration exposure
Traders and investors manage duration exposure by shifting between long and short-dated instruments. Shortening portfolio duration (moving from TLT to SHY) reduces interest rate sensitivity. Lengthening duration increases it.
During rate-hiking cycles: reduce duration by moving toward shorter-dated bonds, cash, and floating-rate instruments. During rate-cutting cycles: extend duration to capture price appreciation as yields fall.
In equity portfolios, duration management means shifting between growth (high implicit duration) and value/dividend stocks (lower duration). In rising-rate regimes, overweight value, financials, and energy. In falling-rate regimes, overweight growth, utilities, and REITs.