Assess how a portfolio's rate sensitivity compares with its benchmark's using key rate durations
The idea
A key rate duration measures sensitivity to a shift at one maturity point on the curve, holding the others fixed, and the key rate durations of a portfolio sum approximately to its effective duration. Comparing the portfolio's profile with the benchmark's shows where it is overweight or underweight curve risk. The approximate relative return from a curve move is −Σ (portfolio KRD − benchmark KRD) × change in that key rate. For example, if the portfolio's 10-year key rate duration is 1.2 above the benchmark's and the 10-year yield rises by 20 bp, the portfolio lags by roughly 1.2 × 0.20% = 0.24%. The trap is summarising curve risk with a single duration number.
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