Managing Bonds in a Rising Rate Environment




Pictured left to right: Peter Baden, CFA, chief investment officer; Tom Williams, managing director; and Rick Bell, portfolio manager.

Photo by Daniel Smyth

 

We are now entering an interesting phase in the fixed income marketplace. After a cyclical decline of more than 30 years, interest rates are expected to move higher as the Federal Reserve Board has indicated it will raise short-term rates in 2015. It is important for investors to understand the implications of higher short-term rates and the potential outcomes. Although it is possible that interest rates will rise across the entire maturity spectrum, we believe it is more likely that long-term rates will hold steady due to a lack of economic growth. Many investors have been sitting in money market funds for years in anticipation of higher rates. Unfortunately, rates have not budged and money market funds, bank CDs and short-term treasuries have failed to produce sufficient income for investors.

 

The Cost of Cash

As we have seen in recent years, timing interest rate movements can be challenging. Investors who sold fixed-income holdings are unlikely to have reinvested at higher rates and are still waiting for their opportunity. The opportunity cost of not being invested can result in a failure to meet short-term income needs and long-term financial goals. 

For example, when talk of an improving economy began in 2010, if you were to have invested $100,000 in a five-year AAA tax-free municipal bond earning 1.60 percent, you would have earned a total of $8,000 in tax-free income and be getting your principal back at maturity. High quality money market funds have yielded almost nothing over the same time period.

 

Active Management

Ross, Sinclaire & Associates, LLC (RSA) utilizes actively managed strategies to mitigate risk and capitalize on opportunities created by changes in the market. Buy and hold strategies, in contrast, limit the ability of a manager to take advantage of various market environments. 

A common example is a laddered portfolio of staggered maturities whereby a manager may reinvest as bonds mature, but foregoes any price appreciation that may have occurred. As an active manager, we construct portfolios with specific price targets for each bond. We sell as valuations rise to capture price appreciation and redeploy cash to undervalued bonds. This process enables us to increase current income in rising interest rate environments by selling lower yielding bonds in favor of higher yielding bonds. 

RSA recently implemented a new strategy to capitalize on changing market dynamics in which five-year municipals began trading at levels exceeding our price targets. We are selling 4-7 year maturities and repositioning portfolios in a barbell structure with an emphasis on 2 and 10-year maturities. This allows us to increase yield while maintaining a 5-year modified duration.

 

Customization

We believe that in order to achieve optimum returns, clients should own individual bonds, actively managed in a portfolio tailored to the specific needs and objectives of the client. We assess the risk/return profile and income needs of each client and structure a customized portfolio to achieve those objectives. There are a variety of ways to invest in fixed-income including bond mutual funds, bond ETFs, and separately managed accounts (SMA). 

In contrast to individual bond portfolios, bond funds and ETFs maintain constant maturities and are likely to decline in value as rates rise, which will result in a permanent loss of principal. Owning a portfolio of individual bonds enables investors to ride through the volatility and hold bonds to maturity if necessary. We offer clients the benefits of individual bonds in a customized, separately managed account format. 

RSA has the combined resources of an established brokerage firm and an SEC registered investment advisory firm. We have assembled a team of experienced professionals that understand portfolio management, credit research, quantitative analysis and client service. RSA carries one of the largest inventories of municipal bonds and has a robust sales, trading and municipal underwriting group to complement the investment advisory team.

Ross Sinclaire and Associates is located at 700 Walnut Street, #600, Cincinnati, OH 45202. You can reach them at 513.381.3939 or visit their website at www.rsanet.com.

Investing involves risk, including the possible loss of principal. The information contained herein has been prepared solely for informational purposes. Nothing contained herein should be construed as a recommendation to buy or sell any security. Ross, Sinclaire & Associates, LLC is a registered Broker-Dealer, an Investment Advisor registered with the U.S. Securities and Exchange Commission (SEC), and a member of FINRA and SIPC. Registration with the SEC does not imply a certain level of skill or training. Investment products are not FDIC insured, offer no bank guarantee and may lose value.