5 Tools To Manage Interest Rate Risk

December 16, 2015

Deciding how to hedge interest-rate risk begins with a personal assessment: What kind of fixed-income investor are you?

The Federal Reserve is expected to raise interest rates today for the first time in nearly seven years. If the era of post-financial-crisis, ultra-low rates is coming to an end, managing that transition to higher rates is imperative.

There are different ways to manage a portfolio in a rising-interest-rate environment. It’s not just about reducing interest-rate risk and duration, it’s about sticking to what you are trying to achieve in your overall portfolio.

Different Kinds Of Risk Tolerance

Different people have different risk tolerances, and they want different things out of their fixed-income allocation. Some turn to fixed income merely for diversification; some hunt for yield; some just want predictability of income at the end of the road.

We outline below five broad groups of investors, and the solutions that may apply to them.

1. The Diversifier

“If there’s someone who looks at fixed income as ballast to their portfolio, a ballast against equities, they may not want to reduce interest-rate risk at all,” Matt Tucker, head of fixed income for iShares, told ETF.com.

The reason for that, he says, is due to the historical low or negative correlation between stocks and bonds. For many, fixed income is a diversifier to equity exposure, and a lot of that diversification benefit comes from the interest-rate risk that bonds have.

“A typical investor who is investing in a fund such as the iShares Core U.S. Aggregate Bond ETF (AGG | A-98) may want to hold on to that investment, because even in a rising-rate environment, they are going to get the diversification benefits of that exposure,” Tucker said.

“Timing a rising-rate environment is very difficult,” he added. “For the investor who is long-term-minded and looks at fixed income as a diversifier, they should be comfortable leaving that allocation as it is.”

So far this year, a lot of investors have opted for this strategy—more than $7.1 billion in fresh net assets have flowed into AGG year-to-date, making the fund one of the most popular strategies of 2015.

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