By Daniel Beckerman Much of our strategy in terms of risk management with the Asset Allocation portfolio has increasingly been associated with our viewpoints on interest rates and fixed income. Rather than discuss particular trades, I thought that it would be most helpful to provide some commentary in terms of our viewpoints in this area.
Many investors own bonds as part of their overall portfolio. Bonds are often thought of as the safety portion or "anchor" to an investment portfolio. However, bonds overall are in a precarious situation as rates have remained quite low. Bonds and interest rates have an inverse relationship. Now that the US Federal Reserve has increasingly been talking about when to raise rates, this issue is becoming much more prominent.
Low interest rates has created an asymmetrical risk situation, making bonds (overall) a particularly bad bet at the moment. That is because interest rates have a lot of room to increase over time, whereas there is not much room for rates to decrease. For every one percent move up in interest rates treasuries can lose as much as -8.5% (for the 10-year treasury bond) and -17% or more (for the 30-year bond). Because bonds are an important piece of an overall asset allocation, we have identified some strategies that we believe can help in reducing the interest rate risk associated with fixed income.
Buy Short Term Bonds
Look to minimize duration in a bond portfolio in order to limit interest rate risk. Duration measures sensitivity to interest rate changes. It is defined based on the number of years it takes for the lender to recoup their investment. Generally investors should keep their duration relatively low in preparation for rising interest rates. If I am invested in a short term bond such as a two year US government note, it can still lose value if short-term rates go up.