Rising interest rates, tightening monetary policies, and increasing inflation expectations present new risks
Financial markets got off to a rocky start in 2018 as gain-chasing Bitcoin investors got burnt and equity markets went through the worst volatility rout in years. Given changes like a new Fed chairman, rising rates, and tightening inflation, the fixed-income market is expected to undergo shifts of its own, and investors have to position themselves accordingly.
“Investors and managers have a lot of tools at their disposal to dampen the impact of further rate increases,” said Josh Jenkins, portfolio manager at US-based CLS Investments, said to ETF.com. “There are tons of options in the short-to-ultrashort bond ETF space to target a lower duration.”
Jenkins said investors should also remember that higher rates are actually better for investors since they are a strong predictor of improved returns. Mike Arone, chief investment strategist at State Street Global Advisors, agreed, saying the current trends stoking investor fears aren’t a reason to abandon bond allocations — but should supplement them.
“Investor portfolios are vastly overallocated to investment-grade corporate bonds and high-yield bonds,” Arone said. “Given the credit risks investors are taking for the narrow rewards they’re receiving in these bond sectors, I suggest investors complement existing credit positions with senior loans.”
Meanwhile, Jerome Schneider, head of short-term portfolio management and funding at PIMCO, said that investors in passive strategies are likely at a disadvantage as yields rise. Referring to a supply and demand imbalance as issuance increases, he said investors who want to lower their portfolio risk and capture liquidity premiums could have a tremendous opportunity in their hands.
And although the US Treasury yield curve so far has shown increased rates, WisdomTree Senior Fixed-Income Strategist Kevin Flanagan noted that the past two years have shown instances wherein not all rates moved in the same direction as the Fed raised rates. “Against this backdrop, we feel investors using a floating-rate product may be better able to insulate their bond portfolio as compared to a more traditional defensive fixed-income investment,” he said.
Finally, Bob Smith, chief investment officer at Sage Advisory Services, said investors should consider disaggregating the bond index into sub-sectors based on duration and quality. From there, they can look for the ones that will do better, and focus on those rather than commit to broad fixed-income-market positions.
“It is also important to note that interest rate and credit spread cycles are not synchronized, and often run in different measures and time frames,” he said. “As such, a fear of rising rates, near or longer term, needs to be considered relative to those investment sectors that will be adversely affected in the early parts of a monetary tightening cycle.”