Fixed Income, (Eventually) Rising Rates and the (Non) Universal Law of “Bond Gravity”

July 25, 2014 | Kweku Obed, CFA, CAIA, Managing Director

While we cannot predict exactly when and by how much rates will rise, the Federal Reserve (“Fed”) has recently signaled that we could see a modest increase in the fed funds rate by mid-2015. Given the increased possibility of rates rising over the next few years, investors should not retreat in fear from bonds en masse or look to underweight their fixed income allocations to anemic levels. Instead, they should continue to view fixed income as strategically important: after all, fixed income is a broad asset class with a diverse opportunity set. And, while we will summarize our views on some different sub-asset classes in this paper (including floating rate bonds, non-U.S. debt and convertibles), for additional reading on non-core fixed income sub-asset classes, please refer to our previously released papers on global fixed income, emerging markets debt, high yield, and senior secured loans.

In respecting the broadness of our client base, we seek to avoid a one-size-fits-all narrative on how they could look to manage their bond allocations: some clients will be limited in their ability to access certain sub-asset classes while others will have ample room and resources to maneuver across the choice spectrum. Consequently, there are a number of prudent approaches and strategies for these different types of investors to explore as a means of hedging their interest rate risk. The key is establishing which portfolio framework or sub-asset class exposure is the best fit for their programs and in line with their circumstances, risk tolerances, and investment goals.

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