What does the term 'duration' refer to in investment management?

The term 'duration' in investment management primarily refers to the sensitivity of a bond's price to interest rate changes. It is a crucial concept in fixed-income investing as it measures the time-weighted average cash flow timing of an investment's cash flows, which can include coupon payments and the return of principal at maturity.

When interest rates rise, the prices of bonds generally fall, and the extent of that price change can be estimated using duration. A bond with a longer duration will experience a more significant price decrease when interest rates rise compared to a bond with a shorter duration. This relationship makes duration a vital tool for investors in managing interest rate risk within their bond portfolios. Understanding duration allows investors to make informed decisions regarding bond selection and to assess the potential impacts of interest rate fluctuations on the value of their investments.