For much of this year, we have encouraged investors to look at their core fixed income exposures in a different light. Core bond strategies need not be driven by market capitalization or the discretion of an active portfolio manager. Disciplined, passively managed strategies can be constructed to enhance income potential while broadly maintaining the risk characteristics of the investment-grade universe.
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As 2016 draws to a close, many investors are evaluating what (if any) changes need to be made to their portfolios for 2017. For fixed income investments, a crucial question will be how much interest rate risk is worth taking as we head into the new year.
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For the second year in a row, the Federal Reserve has given the financial markets a rate hike in December. The natural question now is whether U.S. policy makers will follow this year’s playbook for 2017, or will they blaze a new trail and potentially raise rates more than once per year?
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In anticipation of drastic or unidirectional interest rate movements, bond investors typically choose to either dial up or down their duration profile. One common way to do this is using U.S. Treasury futures to hedge duration in a portfolio of high-yield or investment-grade bonds. However, for many investors, constantly adjusting the hedge ratios for a portfolio can be cumbersome and out of their comfort zone.
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Over the two weeks ending November 18, the yield of the 10-Year Treasury soared 57.9 basis points. Over the last 30 years, only two such periods saw larger increases—April 10, 1987, and November 23, 2001—making this November the third largest rise in the 10-Year Treasury yield.
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If there has been any lesson to be learned in the fixed income arena since election day, it is that, yes, interest rates can go up. There seems to be little doubt fixed income investors had become increasingly accustomed to the opposite scenario in 2016.
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