Rising interest rates are never fun for bond investors, as bond prices generally fall as yields rise. The latest move in rates has been no different, with the Bloomberg Barclays U.S. Aggregate Bond Index down 2.6% since bond yields started moving higher in earnest on September 7, 2017.
Bonds can be an important part of a diversified portfolio, but is there anything investors can do to help limit the impact of rising rates on their fixed income holdings? A couple of key points to consider are:
- Maintain sector diversification and yield curve positioning. The coupon rate a bond pays and the amount of time until it matures are two factors that impact a bond’s interest rate sensitivity (known as duration). The chart below shows how different bond sectors have performed during periods of rising interest rates. John Lynch, Chief Investment Strategist explains, “Though the environment does not rule out volatility, history has shown a diversified strategy employing below-benchmark duration risk and above-benchmark credit risk may be additive to portfolios over time.”
- Keep a long-term perspective. Interest rates can change quickly, and bond prices can adjust just as fast. However, the income derived over time from the coupon payments tends to be the main driver of a bond’s total return. So even if prices fluctuate in the near term, assuming an issuer doesn’t default, an investor in an individual bond will receive the full principal amount invested when the bond matures. There are times when investors need to sell their bond(s) prior to maturity for liquidity or other reasons, but keeping a long-term focus gives investors the best opportunity to benefit from the income stream that drives the long-term performance of bonds.
We discussed the impact of rising rates in more detail in this week’s Bond Market Perspectives, “Managing Interest Rate Risk”.
The opinions voiced in this material are for general information only and are not intended to provide or be construed as providing specific investment advice or recommendations for any individual security.
Past performance is no guarantee of future results.
The economic forecasts set forth in the presentation may not develop as predicted.
Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values and yields will decline as interest rates rise, and bonds are subject to availability and change in price.
Government bonds and Treasury bills are guaranteed by the U.S. government as to the timely payment of principal and interest and, if held to maturity, offer a fixed rate of return and fixed principal value. However, the value of fund shares is not guaranteed and will fluctuate.
Mortgage-backed securities are subject to credit, default, prepayment (that acts much like call risk when you get your principal back sooner than the stated maturity), extension (the opposite of prepayment), market, and interest rate risk.
High-yield/junk bonds are not investment-grade securities, involve substantial risks, and generally should be part of the diversified portfolio of sophisticated investors.
Municipal bonds are subject to availability, price, and to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise. Interest income may be subject to the alternative minimum tax. Federally tax-free but other state and local taxes may apply.
There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not ensure against market risk.
All market indices discussed are unmanaged and are not illustrative of any particular investment. Indices do not incur management fees, costs and expenses, and cannot be invested into directly
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