Bonds can still thrive in a higher-rate environment.
“If the economy is strong enough to warrant a rise in interest rates, that’s actually good for corporate issuers, both high-yield and investment-grade,” says Nicholas Leach, vice-president of global fixed income, high yield at CIBC Asset Management.
“As the economy improves, companies are able to grow their revenues and cash flows, and improve their credit metrics. Default rates tend to be much lower. Credit spreads tend to tighten, and that provides a pretty good cushion for bondholders in the event of rising interest rates,” he says.
When the economy improves, managers should change their portfolio mixes, says Jeff Waldman, head of global fixed income at CIBC Asset Management.
“Tilt the portfolio away from the government sector toward the corporate sector. The manager can shift the mix within the corporate sector to those securities that carry a lower credit quality rating, and a lower proportion of government securities overall,” says Waldman.
Read: Up the risk in TFSAs
“The manager can also adjust the mix of corporate securities to companies that are more pro-cyclical — that is, those that will outperform in a stronger economic environment, such as industrials and energy, and shift the mix away from defensive industries like infrastructure and securitized notes,” he says.
Plus, “the manager can reduce the average term to maturity of the portfolio, so that the portfolio has lower sensitivity to rising interest rates,” Waldman adds.
Patrick O’Toole, vice-president of global fixed income, active bonds at CIBC Asset Management, says, “We can also do things like increase cash weightings, or change the mix of the bonds along the yield curve.”