During times of rising interest rates, investors should keep a close eye on fixed income.
For individual investors and money managers alike, rising interest rates cause a problem, especially when managing a portfolio with targeted equity versus bond allocations. If one plans to keep a 60/40 stock-to-bond allocation, a rise in interest rates can veer those plans off course.
Most notably, rising interest rates, like a Federal Reserve rate hike, will depress the market value of older, lower interest rate fixed income issues. This may, in turn, depress your return for the year.
But if you are managing an income stream from your portfolio, like a retiree who uses it to pay bills—specifically one that you need to sell shares of bond mutual funds to distribute the needed cash from your portfolio—selling shares of bond mutual funds can be harmful, as the share value of the fund will likely be down because of rising interest rates.
One place to shift some of your fixed income allocation is to high yield bonds or bond funds. There are advantages to high yield, along with some risk
High yield bonds are normally less sensitive to interest rate increases. While it is proper to expect bond prices to move inversely to rates (when rates go up, bond prices tend to come down), higher yielding bonds usually move less. So, it is a defensive move in that regard, but it should also increase the cash flow into your portfolio with the accompanying higher yields.
There are plenty of high yield bond options for investors:
This ETF tracks the ICE Bank of America U.S. High Yield Constrained Index. The fund invests at least 80% of its assets in the holdings of the underlying index while investing at least 90% of its assets in fixed income securities included in the underlying index. It is reported that the underlying index is designed to provide a broad representation of the U.S. dollar-denominated high yield corporate bond market.
This ETF seeks to track the investment results of the Markit iBoxx USD Liquid High Yield 0-5 Index, which is composed of U.S. dollar-denominated, high yield corporate bonds with remaining maturities of less than five years. The benefit here is twofold in a rising interest rate environment. One is that it is high yield corporate bonds. The other is that the maturities are less than five years. Shorter-term maturities are less sensitive to interest rate changes than are longer maturities. In the case of rising interest rates, a portfolio with shorter maturities will be hurt less than one with longer maturities.
This ETF seeks to provide investment results that correspond to the price and yield of the ICE Bank of America US High Yield Index. The fund invests at least 80% of its assets in the securities comprising the index and in securities determined to have economic characteristics substantially identical to those of the securities that comprise the index.
This ETF tracks the DB Global Short Maturity High Yield Bond Index. The fund invests at least 80% of its total assets in the components that comprise the underlying index. The index is composed of bonds issued by corporations, as well as sovereign or quasi-government entities, denominated in U.S. dollars rated below investment grade. The securities must not have been marked as defaulted by any rating agency, have three years or less to maturity, have a minimum amount outstanding of at least $250 million and have a fixed coupon.
These are just four funds worth considering, especially the short-term ones for those more concerned about risk. Remember, high yield bonds tend to be more volatile than those of better credit quality.
Despite presenting a strategic advantage during a period of rising interest rates, they also may add volatility to your portfolio.