What it means
Maturity is the date on which a loan or bond is repaid. A long-dated asset has a distant maturity, commonly many years or even decades, so the holder waits a long time for the principal and receives interest along the way.
What counts as long-dated depends on the market, but bonds longer than ten years are often described this way. The longer the wait, the more the price reacts to interest rate changes.
If market rates rise, the fixed interest on an existing bond looks less attractive and its price falls, and the fall is bigger for longer-dated bonds. Duration (a measure of how sensitive a bond's price is to a change in interest rates) captures this effect in a single number.
Long-dated assets also tie up money. A bank holding fixed-rate mortgages for 25 years but funding itself with short-term deposits has a mismatch, because it must keep renewing its funding while the income from the assets is locked in.
This is a classic cause of financial stress when rates move. On the positive side, long-dated assets usually pay higher yields than short-dated ones, a reward for locking money away and accepting more price risk.
Pension funds and life insurers often like them because they match long-dated obligations to members, which reduces uncertainty. Other risks matter as well.
Inflation can erode the value of fixed payments over many years, and the borrower has more time in which its credit quality can change. Liquidity can also be poor, since some long-dated assets trade rarely.
Accounting treatment adds another layer. Assets held for trading are normally shown at market value, so price falls hit reported profit immediately, whereas assets held to collect payments until maturity may be carried at cost.
This can hide losses on paper, but it does not remove the economic risk if the holder is forced to sell.
In practice
Real-world examples.
Example
A life insurer buys 30-year government bonds to match payments it expects to owe policyholders in several decades. It accepts price swings along the way because its obligations are equally long-dated.
Example
A regional bank reviews its balance sheet and finds that 40% of its assets are 20-year fixed-rate loans. The treasury team uses derivatives to reduce the exposure if short-term funding costs rise.
Example
A small investor buys a 25-year bond fund and is surprised to see it fall 10% in a year when interest rates rise sharply, even though no borrower has defaulted.
Formula
Calculation
Approximate price change % = - Modified duration x Change in yield
Price change in dollars = Price change % x Current value
Suppose a pension fund holds long-dated bonds worth $20,000,000 with a modified duration of 15 years.
If market yields rise by 1 percentage point (1%), the approximate price change is -15 x 1% = -15%.
Dollar change = -15% x $20,000,000 = -$3,000,000, so the bonds fall to about $17,000,000.
For comparison, a short-dated bond portfolio of the same size with a duration of 2 years would fall only 2 x 1% = 2%, or $400,000.
The duration formula is an approximation that becomes less accurate for large yield changes.Case study
Seen in the real world.
Cedar Valley Savings is an illustrative, fictional community lender that held $500,000,000 of fixed-rate loans averaging 20 years, funded mostly by deposits that customers could withdraw at short notice. For years this earned a comfortable spread because short-term rates were low.
When short-term rates rose, the bank had to pay more to keep deposits while its old loans continued to earn the same low fixed rate. The value of the loan book also fell, and selling any of it would have crystallised a loss, so management could not simply cash out.
The fictional bank survived by raising longer-term funding and selling some loans gradually, but its earnings were squeezed for several years. The story shows why long-dated assets reward careful matching of assets and liabilities. Directors later added a rule that the average maturity of assets must stay within a set distance of the average maturity of funding.
Watch out
Common mistakes.
- Assuming that safe issuers make long-dated assets safe, when government bonds with long maturities can still lose a large share of their market value.
- Comparing yields without comparing maturities, and so missing the extra interest rate risk carried by the longer asset.
- Treating accounting value as market value, when assets held to maturity may hide large unrealised losses.
Questions
People also ask.
Are long-dated assets riskier than short-dated ones?
In terms of interest rate sensitivity, yes, because price changes are larger, though some investors with long obligations find them lower risk overall.
What counts as long-dated?
There is no single rule, but in bond markets maturities beyond ten years are often described as long-dated, and beyond twenty as very long.
Why do institutions hold them?
To match long-dated liabilities, to earn higher yields, and to lock in income for many years.
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