Clarifying, 7 is my avg maturity, not the duration. My avg maturity is lower than ZAG, VAB, XBB. My duration is probably a bit lower than theirs as well.With a fund like your fund, ZAG, VAB, or XBB ... a growing concern is duration risk that the fund value will drop as rates rise. ZAG has a duration of 7 similar to yours.Right, the Canadian bond market moves very similarly to the US bond market.The US Fed is expected to raise rates about 3 or 4 times during 2017 for approximately an increase of .75 - 1%. Even though its US rates, it obviously effects rates in Canada when you study the charts.You're echoing some common misconceptionsshould these 7 year duration funds not be expected to drop about 7% in fund value by the end of the year?
(1) The central bank is raising the overnight rate, but this is not the same as the bond yield, especially not at 10 year maturity on the yield curve. Here's a web site that shows the US yield curve.
The Federal Reserve, or Bank of Canada, etc only directly changes the short end of the curve: the cash rate. They do not change the other rates on the yield curve; that's determined by the bond market. Let's say the Federal Reserve does raise rates a total of 1.0%. What will happen to the 10 year point on the yield curve? Who knows -- it could go down, up, or stay the same.
This is one of the key misinterpretations about the Fed "raising rates" and its impact on bond funds. Even if we think it's 100% certain that the Fed will raise rates by one percent, we don't know what will happen to the yield at 10 years on the yield curve. For example: the bond market might have already priced this in. That means that by the time the Fed raises rates, it's old news to the bond market and perhaps the 10 year yield does not react at all.
Between Jan 2004 and Jan 2007, the Federal Reserve increased the fed funds rate a whopping +4.25% and the 10 year yield increased just +0.3%. This was a far more aggressive rate tightening regime than today, and yet bond funds (like AGG exposed to the 10 year yield) did very well. AGG returned +3.42% per year. I should add that early in this time line it did decline, temporarily, 5%.
(2) That calculation where duration translates to % move is applicable to an individual bond. If you have a specific govt bond with duration=7 and if the yield of that bond increases by 1% then yes, the price is expected to drop 7%.
For the rest of this discussion I will assume we're talking about a 1% increase in the yield of the 10 year, which as I described in (1) is not necessarily what happens when the Fed raises rates by 1%
With the bond fund, yes if the rates suddenly increase by 1%, then the fund with duration=7 will decline by 7%. However once you start spacing it out over time, you're also getting interest earned on bonds, and new bonds that bring in higher levels of interest due to the increase in rates.
So yes it's true that a sharp increase in rates can cause that 7% price decline as you mention. However, gradual increases in rates won't cause that effect.