Protecting a bond portfolio from rising rates

For the first time in a decade, fixed income investors face a rising rates environment. The US Federal Reserve raised interest rates a further quarter point in March, its sixth hike since the global financial crisis, and there could be two or three more before the year is out. Other central banks are further behind in the tightening cycle, but the days of easy money are clearly numbered.

Global rates markets sold off sharply in early 2018 as investors saw the ‘great reflation’ trade that proved elusive through much of 2017 moving closer to reality. The yield on 10-year Treasuries hit a three-year high of 2.95% in February, a level most analysts didn’t expect it to reach until at least the end of this year. Bunds and gilts have recovered some of their losses in the weeks since, but USTs have since broken new ground above 3%, a full 60 basis points above where they started the year.

We all know rising yields are typically bad news for bonds, whose prices fall as yields rise, but the problem is made more acute this time around by the significant increase in the duration of the fixed income market since the global financial crisis.

As central banks have held official interest rates at historic lows, and compounded the effect in the bond market with trillions in quantitative easing, fixed income yields have collapsed, while bond issuers taking advantage of lower borrowing costs have pushed the average maturity of the asset class longer and longer.

As a result, the duration of the fixed rate bond market – or its sensitivity to interest rates – has increased sharply in recent years.

Investors need a strategy to protect their portfolio from this risk.