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Client Conversations: Why Rising Rates Can Be Good For Your Portfolio

As interest rates rise, where can investors turn for growth?

Client Conversations gives financial advisors an easy way to communicate with clients on topics influencing financial markets; it highlights common investor behaviors and offers ways to address the challenges investors face. Share this article with your clients, and remember to follow your firm's policies that govern sharing content with clients and prospects.


Even though it’s a positive sign for the economy, the prospect of rising rates hasn’t exactly left most investors with warm, fuzzy feelings. But while markets have feared rate hikes in the past—as they do most change—it could mean a shift in opportunity toward those sectors that tend to perform well in rising-rate environments. 

 

The Power of Transparency

The US Federal Reserve (Fed) has been very clear about planning to gradually increase interest rates in the post-financial-crisis recovery, which has helped to reduce volatility. As of the time of this writing, three to four increases were expected throughout 2018, helping financial markets set expectations around them. 

Granted, if the pace of rate increases changes, it could stir up volatility again. Fears of rising inflation and a quicker rate-hike cycle were behind a correction in February 2018. By contrast, an economic slowdown could slow further increases. 

As rates rise, where can investors turn for growth? Stocks and real-estate investment trusts (REITs), which are companies that own or manage income-producing real estate, have historically gained when rates moved upward, as shown in Figure 1. Since rising rates are a sign that the economy is growing, the stocks of companies that are doing well in the recovery can benefit from the generally positively macroeconomic environment.

 

FIGURE 1

Stocks, High-Yield Bonds, REITs, and Bank Loans Have Generated Positive Returns on Average in Previous Rising-Rate Environments

Source: Morningstar. Graphic shows the average overall return, over the course of 14 rising-rate environments between 1997 and 2017, for each named sector. Rising-rate environments defined by time periods with a 20% change in 10-year Treasury yields.

Not All Sectors Are Created Equal 

On the other hand, bonds tend not to perform well due to their inverse relationship with interest rates—as rates go up, bond prices generally go down. But some bonds are less interest-rate sensitive than others. 

For example, a type of bond known as a bank loan has a floating coupon that can reset every 30, 60, or 90 days; this feature helps them better hold their value as rates shift. Not surprisingly, high-yield bonds generally offer a higher yield than say, a Treasury bond, because they are more risky. So when rates rise, high-yield bonds are less impacted because their yield is more generous from the get-go.

 

...as rates go up, bond prices generally go down. But some bonds are less interest-rate sensitive than others. 

 

Hypothetical Impact of Rising Rates on a Bond

 

This chart is for illustrative purposes only. In this example, a $1,000 bond would see its price drop to $980 if interest rates rose from 4% to 4.25%. The actual amount of price decrease will vary.

Where to Go From Here

While there are certainly places to look for opportunity in both fixed income and equities as we continue in this rising-rate environment, it’s much more likely to be specific to certain asset classes than widespread. That’s why investing in an actively managed strategy can be beneficial, since they generally have the flexibility to adjust to different interest-rate environments and select specific investments with potential.

If you’re not sure whether your portfolio is ready for rising rates, schedule time to review your portfolio with your financial advisor today. Rising rates could be here to stay—for the foreseeable future, at least—so their impacts shouldn’t be ignored. 

Your advisor can help you create a customized plan to keep you on track with your long-term goals, regardless of the interest-rate environment.

Client Conversations gives financial advisors an easy way to communicate with clients on topics influencing financial markets; it highlights common investor behaviors and offers ways to address the challenges investors face. Share this article with your clients, and remember to follow your firm's policies that govern sharing content with clients and prospects.


1 S&P 500 Index is a market capitalization-weighted price index composed of 500 widely held common stocks.

2 Bloomberg Barclays US Corporate High Yield Index is an unmanaged index considered representative of fixed rate, non-investment grade debt of companies in the US, developed markets, and emerging markets.

3 The MSCI US REIT Index is a free-float market-capitalization weighted benchmark comprised of equity REIT securities that belong to the MSCI US Investable Market 2500 Index.

4 S&P/LSTA US Leveraged Loan 100 Index is designed to reflect the largest facilities in the leveraged loan market.

Important Risks: Investing involves risk, including the possible loss of principal.• Fixed income security risks include credit, liquidity, call, duration, and interest-rate risk. As interest rates rise, bond prices generally fall. • Investments in high-yield (“junk”) bonds involve greater risk of price volatility, illiquidity, and default than higher-rated debt securities. • Loans can be difficult to value and highly illiquid; they are also subject to nonpayment, collateral, bankruptcy, default, extension, prepayment and insolvency risks. • Obligations of U.S. Government agencies are supported by varying degrees of credit but are generally not backed by the full faith and credit of the U.S. Government. • The main risk of real estate related securities is that the value of the underlying real estate may decrease in value. 

This information should not be considered investment advice or a recommendation to buy/sell any security.  In addition, it does not take into account the specific investment objectives, tax and financial condition of any specific person. This information has been prepared from sources believed reliable but the accuracy and completeness of the information cannot be guaranteed. This material and/or its contents are current at the time of writing and are subject to change without notice. This material may not be copied, photocopied or duplicated in any form or distributed in whole or in part, for any purpose, without the express written consent of Hartford Funds.

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