Bonds and Rising Interest Rates
My column in TheStreet.com on bond strategies for rising interest rates
3 Great Ways to Protect Your Bond Portfolio
NEW YORK (TheStreet) — If you’d like to protect your bond portfolio from rising interest rates you might consider a bullet. Or you could stay on top of rising rates with a ladder. If you don’t like bullets or ladders, you could work with a barbell to strengthen your portfolio.
Sound crazy? It won’t when you’re done reading this.
Most investors expect the Federal Reserve to start raising its short-term interest rate target, the federal funds rate, this year.
In testimony to Congress, Fed Chair Janet Yellen recently said:
“As we’ve said all along, we have no judgment at this point about the appropriate date to raise the federal funds rate. Our judgment about that will depend on unfolding economic developments. … If the economy evolves as we expect, economic conditions likely would make it appropriate at some point this year to raise the federal funds rate target.”
When interest rates rise, bond prices fall. The sensitivity of a bond’s price to changes in rates can be measured by a complex mathematical formula known as the duration. The duration of a bond factors in current yield, yield to maturity, maturity date, call provisionsand other variables. All other factors being equal, bonds with longer maturity dates will be more sensitive to changes in interest rates than bonds with shorter maturities.
We’ve seen a lot of movement in rates over the last 35 years. In 1981 the yield on the benchmark 10-year Treasury note hit an all-time high when it touched 15%. In July 2012 it hit a 200-plus-year low when it was yielding 1.45%. Currently the 10-year yields about 2.35%, so the markethas been pushing rates higher over the last couple of years.
If you’re a fixed-income investor who owns individual bonds rather than bond mutual funds, there are some basic strategies you can be using in an environment of rising rates.
One is the barbell. With a barbell you’ll have half your funds invested in long-term bonds to get some yield and the other half in short-term bonds. The strategy looks like a barbell as it is weighted at the ends with nothing in the middle. As the short-term notes come due they are rolled over into new short-term issues.