Choose shorter terms as rates rise

An abrupt rise in U.S. interest rates means investors should reduce risk by purchasing shorter-term bonds, says Pablo Martinez, assistant vice president at CIBC Asset Management. He is co-manager of the Renaissance Canadian Bond Fund.

Instead of buying a 25- or 30-year bond, investors should buy a 5- to 7-year bond, he suggests. That way, when interest rates move up, the investor’s loss will be reduced.

“For the shorter term, we will see rates stabilizing,” he says. “In the mid- to long-term I think rates will be higher than where they are right now.”

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And when there’s a bond sell off, liquidity becomes an issue. “A lot of investors are rushing to the exit, so you want to buy bonds that are more liquid,” says Martinez.

This includes bonds that come with a better credit rating because they’ll be easier to buy and sell.

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Further, investors have been buying high-yield credit. But this has to stop due to the rising rate environment.

“You have to think about security here,” he says. “So it would be time to buy bonds of better quality to make sure that liquidity is still there. You want to buy bonds that are issued in bigger size.”

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He adds that for the next two years, investors should focus on those types of bonds, “even if it means that the yield is going down slightly.”