If clients are worried about rising interest rates, help diversify their fixed-income holdings.
Rather than suggesting laddered portfolios or traditional bonds, for example, focus on investment-grade and high-yield corporate bonds, says Patrick O’Toole, vice president of global fixed incomeDynamic (Income) at CIBC Asset Management. He co-manages the Renaissance Canadian Bond Fund, an underlying fund in the Renaissance Optimal Income Portfolios.
As well, urge clients to consider how active management may help them deal with duration risk, which refers to a bond’s sensitivity to interest rate fluctuations.
“If [they’re] worried about rates rising, [they’re] going to be better off with lower duration,” says O’Toole.
People can also look at floating-rate funds. The only problem is those vehicles “can be a bit dangerous,” he adds. “If rates are going to stay low for a long time, which is [CIBC’s] view, [floating rate funds] may be a little too defensive.”
But if rates do move up, says O’Toole, floating-rate funds could be a good investment. Clients can also monitor the performance of real-return bonds over the next few years since “rates [went] up last year and they will go up again.”
Over the same period, he predicts fixed-income investors won’t have to worry about markets. That’s mainly because bear markets in bonds over the last 60 years haven’t been nearly as harsh as stock market drops. On average, says O’Toole, investors recover from fixed-income losses in about five months—“a fraction of how long it takes to recover your losses from a bear [stock] market.”
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This was seen last year when the DEX Universe dropped 5.25% between May and September. By early March, nearly all losses had been recouped, says O’Toole.
The lesson for investors is they need to stay focused on medium and long-term trends since “returns in fixed income are going to remain positive [in] the long run,” says O’Toole.
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