In duration management, when should an investor lengthen duration?

Lengthening duration is a strategy employed by investors when rates are expected to fall. This strategy is based on the inverse relationship between bond prices and interest rates. When interest rates decline, the prices of existing bonds with fixed coupon rates increase. By holding bonds with a longer duration, the investor can benefit more significantly from the price appreciation that occurs when rates drop.

This approach leverages the fact that longer-duration bonds are more sensitive to changes in interest rates—meaning their prices will fluctuate more dramatically in response to rate changes compared to shorter-duration bonds. Thus, if an investor anticipates a decrease in interest rates, increasing duration can enhance potential returns due to their increased price sensitivity to interest rate movements.

The other options represent scenarios where lengthening duration would generally not be advisable. For instance, expecting rising rates would suggest reducing duration to minimize price losses on bonds. Similarly, with increasing inflation, fixed income securities tend to underperform, leading investors to potentially favor shorter duration assets. High market volatility might lead to increased uncertainty about interest rate movements, which typically does not support lengthening duration as a strategy since the investor would prefer to manage risk rather than extend exposure.