Written by Mark A. Vergenes
After years of low interest rates, the Federal Reserve Board has been raising rates. If you are one of those addicted
to financial cable TV channels, you should be asking questions of your Financial Advisor.
Financial professionals can help by explaining how different types of investments react differently to interest rate increases.
Lately, the cable TV financial channels and business news podcasts have been filled with talk of the Federal Reserve Board (the Fed) and the potential for more interest rate hikes.
While few are predicting a return to the early ‘80s when a lowly, no-risk, 6-month certificate of deposit (CD) was paying back almost 18%, interest rates have started to get off the floor. You (Investors) may be wondering what this could mean.
Income investors, those who want their investments to return real money that they can spend now rather than seeking pure growth, may be looking at their next steps.
The Fed has twice raised interest rates since the November election. And some online banks are offering more than 1% interest on savings. Yield on 10-year Treasury bond (money that is leant to the government in exchange for interest payments) crept up from a record low of 1.375% in July 2016 to something closer to 2.6% in March of 2017.
Transamerica Senior Investment Analyst Kane Cotton, CFA®, reviewed this year’s prospects with an eye toward investment classes that may benefit from or protect against rising interest rates. He came up with a few things to keep in mind in a rising rate environment.
Riding the tide. Short-duration bonds (basically short-term loans you may make to a government or a company) can deliver returns that are less sensitive to changes in interest rates than longer dated bonds. You can even “float” up or down with interest rates with something called a “floating ate” fund. These funds are made up of bonds that make coupon payments which rise and fall with market interest rates such as the London Interbank Offered Rate (LIBOR). While they do carry credit risk, this floating rate feature typically means less sensitivity to changes in market interest rates. Getting “real.” Seeking a real or “inflation-adjusted” return can lower correlation to the market. U.S. Treasury inflation-protected securities (called “TIPS”) periodically adjust their principal for inflation with the intention of allowing an investor’s returns to outpace inflation over time.
Being active. Actively managed, multi-sector funds with flexible mandates may be able to shift allocations to sectors that, unlike U.S. Treasuries, are less correlated to interest rates. They can also pursue opportunities to earn higher yields.
Getting credit. Consider taking on some credit risk in place of interest rate risk by looking at investments with a yield that’s better than the U.S. Treasury’s. Consider credit such as investment grade or high yield corporate bonds.
Going global. When U.S. rates rise, foreign markets may offer attractive opportunities, relatively speaking. Interest rate cycles can differ by country and region. Look at corporate and government debt opportunities in overseas markets to seek returns and diversify risk in rising rate environments.
And since nobody can predict the future, Wald reiterates the value of financial professionals, who can help investors decide on a course of action, based on each individual investor’s situation.
“In a potentially rising interest rate environment that may include more risk, we believe it makes sense to take advantage of the expertise and capabilities of a seasoned portfolio manager who understands the implications of the new rate cycle we could be entering,” Wald said.