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White Paper: Bond Strategies For A Rising Rate Environment

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    November 8, 2013

    Bond investing for many has never been more difficult but not for the reason many think.

    Policymakers around the globe began aggressive campaigns of monetary interventions following the financial crisis in 2008. These unprecedented measures to stabilize capital markets and induce economic expansion in developed countries have had far reaching effects. We know that with Federal Reserve intervention interest rates have fallen precipitously while asset prices have surged higher. With interest rates now near historic lows the search for yield by investors has been a difficult task.

    However, it is in that quest for yield that many investors have unwittingly taken on excessive credit risk (the risk of the bond issuer defaulting) by pouring money into “high yield,” a marketing term for “junk bonds.” and emerging market debt. However, the real problem that continues to frustrate most fixed income investors isn’t credit risk but rather interest rate risk.

    Investors have enjoyed a 30-year bull market in bonds while deflation/disinflation has remained the reigning theory.

    In our opinion the risk profile of traditional bond portfolios has changed. Today, traditional strategies benchmarked against the aggregate fixed income universe are dominated by interest rate risk, which is not the most desirable risk after decades of falling government bond rates.

    When the Federal Reserve made the announcement of QE3, what Ben Bernanke said was interesting. Not that policy was being linked to a 6.5% unemployment rate, but that the Fed would tolerate an inflation rate up to 2.5%. So we have to ask ourselves, assuming the Fed does get what it wants, how can you explain interest rates across the maturity spectrum up to the 10-year treasury, will stay below the inflation expectation that the Fed wants to achieve?

    While it’s difficult to predict when rates will rise, investors need to begin thinking about their fixed income strategies and how their portfolios will provide income while helping to shield them from undesired risks.

    It’s time for a new strategy.

    With the 10-year treasury currently at 2.5%, despite all the current angst, it seems to be a base…for now. Investors should begin asking themselves, how should I invest if yields go higher? Most investors think of investing in fixed income with the idea of what has worked for the last 30 years – long bonds. It’s time for a new strategy.

    Most bond funds in a rising interest rate environment are not the place to be. A long duration bond portfolio is less than ideal as well.

    For investors who think rates will rise, we can suggest several strategies. While we do not recommend any of these as pure strategies, as a compliment to a fixed income portfolio some of these strategies should be considered.

    This paper explores the basic strategies for bond investing in a potentially rising interest rate environment.

    Bond Strategies For A Rising Interest Rate Environment.pdf

    Images: Flickr (licence attribution)

    About The Author

    Lance Roberts – Host of StreetTalk Live

    After having been in the investing world for more than 25 years from private banking and investment management to private and venture capital; Lance has pretty much “been there and done that” at one point or another. His common sense approach has appealed to audiences for over a decade and continues to grow each and every week.

    Lance is also the Chief Editor of the X-Report, a weekly subscriber based-newsletter that is distributed nationwide. The newsletter covers economic, political and market topics as they relate to the management portfolios. A daily financial blog, audio and video’s also keep members informed of the day’s events and how it impacts your money.

    Lance’s investment strategies and knowledge have been featured on Fox 26, CNBC, Fox Business News and Fox News. He has been quoted by a litany of publications from the Wall Street Journal, Reuters, The Washington Post all the way to TheStreet.com as well as on several of the nation’s biggest financial blogs such as the Pragmatic Capitalist, Zero Hedge and Seeking Alpha.