For income investors, the threat of soaring interest rates is a nagging risk. If your portfolio is loaded up with the wrong types of bonds, rising rates can devastate your portfolio returns. See here for example.
Rising interest rates don’t impact all bonds in the same way though. Here at Barron’s, PIMCO (via a paid advertisement) makes the case that a properly positioned bond investor need not fear the threat of increasing interest rates. As one of the world’s largest bond fund managers, PIMCO of course has an ax to grind, but the insights they offer remain relevant.
- Bond declines have tended to be modest and short-lived
Bonds have historically been used for capital preservation, income and growth, and diversification due to their low-to-negative correlations to stocks – essential goals for many investors.Bonds, particularly core bonds, have also been less volatile than stocks. As Figure 1 shows, bond declines have been dramatically less severe than stocks and usually short-lived.
- Rising rates build income
Because interest income is the primary driver of bond returns, the ability to reinvest into a gradually rising rate environment has the potential to help build long-term growth. When rates rise, new bonds pay a higher coupon, increasing the income investors receive. By contrast, higher rates can be a headwind for equity investors, as increased borrowing costs weigh on corporate profits.
- Rising rates don’t impact all bonds the same
News about the bond market typically focuses on U.S. Treasuries, which tend to be the most sensitive to changing rates. In reality, the bond market is exceedingly diverse and global, and each sector or asset class responds differently to economic and market trends. Some, such as floating rate bonds, actually have tended to do well in a rising rate environment, as seen in Figure
What are the right type of bonds to own in a rising interest rate environment? Richard C. Young & Co., Ltd has an opinion on this. You can read more about that strategy here. For self-directed investors, Intelligence Report is our advised income investing strategy guide for you.
Jeremy Jones, CFA
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