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In June 2010, we recommended five strategies for a rising-rate environment, acknowledging that we had no idea when or how abruptly rates would rise. Indeed, rates fell since we wrote that article. But they are on the rise again. After reviewing how our original five strategies performed, we’ll now present our revised recommendations for investing as rates increase.
In our previous article, we offered five strategies that advisors could employ to shield portfolios from rising rates. In some cases, we argued, these five strategies would benefit from rising rates: ultra-short bond funds, international fixed income, floating-rate notes (i.e., bank loans), Treasury inflation-protected securities (TIPS) and real assets.
Voss Capital is betting on a housing market boom
The Voss Value Fund was up 4.09% net for the second quarter, while the Voss Value Offshore Fund was up 3.93%. The Russell 2000 returned 25.42%, the Russell 2000 Value returned 18.24%, and the S&P 500 gained 20.54%. In July, the funds did much better with a return of 15.25% for the Voss Value Fund Read More
Overall, these strategies performed admirably between when we recommended them and today. Floating-rate notes, TIPS and our international fixed income recommendations have all outpaced the broader bond market since the article was published. Other recommendations, like gold and commodities, were underperformers, and our ultra-short bond recommendation held its value and paid a modest dividend, as we expected.
There is only one problem: Rates have yet to rise.
In fact, they have fallen (from 3.3% to 2.75% on the 10-year Treasury) since our article was published. Indeed, the bond bull market continued.
As we approach 2014, we are surprised that rates have remained so low for so long. There are various reasons for the low rates: the sluggish economic recovery, the Euro-crisis that monopolized headlines for most of 2010 and 2011 and the aggressively accommodative monetary policy of the Federal Reserve are a few.
The summer stress test
What then can we expect from these asset classes if and when rates eventually increase? And have our recommendations changed?
Fortunately, this summer’s “taper tantrum” provided a decent stress test of how these strategies will work in an environment of sustained interest-rate increases.
The chart below shows what the prices of our recommendations and Vanguard Total Bond ETF (a proxy for the bond market) did from May 1 through Sept. 10 of this year — when the yield on the 10-year Treasury moved from 1.66% to 2.96%. It would be unwise to draw broad conclusions that all of the movement in each fund was due to the move in interest rates. Nonetheless, the movement in rates certainly had a meaningful effect on most.
Clearly, short-duration funds like floating-rate notes and ultra-short government bonds held up very well, exhibiting very little volatility or correlation to the move in rates. TIPS had a very high sensitivity to rising rates. With minimal inflation, TIPS offer more risk in a rising-rate environment than most people realize – primarily because of their high duration. Gold and commodities moved, but the causes were a combination of rising rates and the dynamics of the commodities themselves.
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