In the last article, we introduced the concept of "duration" initially applied to fixed income portfolios. However, it is important to note that the effects of interest rate fluctuations impact not only fixed income securities but also any financial asset.

To explain the reasoning, consider that interest rates (such as SELIC) are discount rates used to price any financial asset, as they represent the opportunity cost for investors. In other words, they reflect the return rate that an investor could achieve by investing in another asset with lower risk.

For example, if an investor's opportunity cost is 10% per year and they are evaluating an asset that promises returns of 8% per year, they will likely not invest in this asset, as the expected return is lower. It would be more worthwhile to invest in a lower-risk asset. Conversely, if the same investor is evaluating an asset promising returns of 12% per year, they will be more inclined to invest in this asset, as the expected return is higher than their discount rate.

It is important to remember that the longer the investment's term, the greater its duration, meaning the greater the sensitivity of the price to changes in interest rates. Stocks, unlike fixed income securities, do not have a maturity date and are thus considered to have much higher duration. Consequently, any variation in interest rates significantly affects their prices.

Some sectors are more sensitive to the duration effect than others. For example, companies characterized as "Value," meaning they are analyzed based on fundamental criteria (such as balance sheet analysis and cash generation), historically have low duration and sensitivity to interest rate changes due to generating larger cash flows in the present.

On the other hand, technology companies, which have high growth potential and many of which are not yet profitable but are expected to be in the more distant future, have higher duration and, consequently, high sensitivity to interest rate fluctuations.

A recent and practical example of this effect occurred in 2022 with major American companies—Apple (AAPL), Google (GOOGL), Microsoft (MSFT), and Nvidia (NVDA). All were significantly affected by the sharp rise in the Federal Funds rate. Other smaller, lesser-known companies traded on U.S. exchanges fell even more, sometimes by 70-80% at the same time.

These companies, on the other hand, saw their stocks multiply several times over in 2020 and part of 2021, when the market disproportionately favored these high-growth potential companies.

**When to Consider Increasing or Decreasing the Duration of a Stock Portfolio?**

The general rule would follow the same logic we presented for a fixed income portfolio. In periods of expected falling interest rates, it might be beneficial to increase the duration of stocks to capture gains from price appreciation. Conversely, in periods of expected rising interest rates, it may be prudent to decrease the duration of the portfolio to reduce the risk of losses. A common approach is to build a more balanced portfolio, considering both asset classes together and aiming for a "balanced duration." For example, if the fixed income portfolio has a very short term, it opens up space for potential allocation in stocks of companies with longer duration (growth companies).

However, this relationship is a simplification for a single variable affecting stock pricing, without considering operational cash flow and how it may impact company returns and prospects. In the next article, we will discuss the effects of operational and financial leverage, which also financially impact company profitability.

‍