Protecting Your Portfolio Against the Threat of Rising Rates

NEW YORK (TheStreet) -- In the wake of an absolutely stellar performance last year, thus far in 2014 we are hearing a lot about what's not working for investors, both professional and retail.

The major indices have had a rocky go of it, and the recent selloff in the Nasdaq momentum names including Netflix (NFLX), Tesla (TSLA) and Amazon (AMZN) has pulled the rug out from under many investors. But there are many investments that have been standing out the past few months -- some of which are getting adequate attention, some which aren't.

After last week's rout, all the major indices (Dow Jones Industrial Average, S&P 500 and Nasdaq) are in negative territory for 2014. Bonds are out-performing stocks for the first time since 2011. Almost exactly a year ago year Warren Buffett called bonds "a terrible investment." He is probably right over the intermediate term and almost certainly right over the long term, as the rewards for ownership are no longer remotely commensurate with the risks.

So what's an investor to do?

Below is a chart reflecting the year-to-date performance of three separate, interest-rate-sensitive asset classes: Utilities (represented by the iShares Dow Jones US Utilities (IDU)), Equity REITs (represented by Vanguard REIT ETF (VNQ)), and Master Limited Partnerships (represented by JPMorgan Alerian MLP Index ETN (AMJ)).

AMJ Chart
AMJ
data by YCharts

While most headlines seem to be encouraging investors to protect their portfolios against the imminence of rising rates, there has been little gained by acting on that advice up to this point. In reality what we have seen is a continuance in the trend of rates moving lower, though not without some turbulence. The chart below shows that the 10-year Treasury remains solidly in a downward trend, despite all of the reasons why rates "should" be heading back towards more "normal" levels.

10 Year Treasury Rate Chart10 Year Treasury Rate data by YCharts

Is it possible that the next 50-basis point move in the 10-year Treasury is down, not up? Why not? And if so, what does that mean for the stock market and the asset classes mentioned above?

Let's take a look at last year's infamous but now all-but-forgotten interest rate spike in May and June. When former Federal Reserve Chairman Ben Bernanke gave the market its first whiff of tapering, the reaction was swift and startling-the 10-yr jumped from 1.90% to 2.50% in five weeks:

AMJ Chart
AMJ
data by YCharts

In much the same vain, as the 10-year rate has come off the 3% level since New Year's Eve, REITs, MLPs, Utilities and Emerging Markets (as represented by Vanguard FTSE Emerging Markets ETF (VWO)) have all found much steadier footing. We outlined some additional bullish points for the emerging markets a couple weeks ago here.

AMJ Chart
AMJ
data by YCharts

It's not always easy to stay diversified -- to maintain allocations to these interest-rate-sensitive assets seemed a fool's errand last year. As a result, many investors have missed out on some very nice performance over the past four months.

So how should we be positioned going forward? In my view, what's worked so far this year is likely to keep working. The chart above demonstrates the 10-year Treasury being range bound and its current yield sitting at the top end of a current range.

Should it fall further from here we are likely to see continued strength in the bond surrogates (AMJ, IDU, VNQ). For taxable accounts, you may wish to consider individual MLPs for the tax advantage -- we like AmeriGas Partners (APU), Energy Transfer Partners (ETP), TransMontaigne Partners (TLP) and Williams Partners (WPZ) right now.

Now, the arguments for higher rates make a lot of sense and shouldn't be dismissed by any stretch. But I'm not ready to bet with the herd just yet.

At the time of publication the author is long AMJ, VNQ, VWO, APU, ETP, TLP and WPZ..

This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.

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