What does this mean for bond investors? And what investing resolutions should you make in 2014?
Here are three we would offer:
1. Traditional bonds could experience losses. For example, if we take a broad category of bond funds held by investors such as the Morningstar Intermediate Bond Category, a 1% rise in interest rates would mean approximately a 5% loss in principal. A 0.5% rise in rates could mean a 2.5% loss of principal, which would offset the income from the coupon payments and lead to overall losses. Longer maturity bonds hold more of this interest rate risk than shorter-maturity bonds, so be mindful of the maturities in your bond portfolio.
2. Since inflation is near flat, bonds designed to protect against loss of value to inflation might not be worth owning such as Treasury Inflation Protected Securities (TIPS). Except in the longest maturities, in our view, they are expensive and we would keep them at a minimum in a portfolio.
3. Bonds that trade based on credit, or the ability of the issuer to pay back its obligations, offer a way to gain income with lower interest rate sensitivity. While not inexpensive, they generally offer higher yields and less sensitivity to interest rate increases. In particular, we favor high yield bonds.
Jeffrey Rosenberg, Managing Director, is BlackRock’s Chief Investment Strategist for Fixed Income, and a regular contributor to The Blog. You can find more of his posts here.
The opinions expressed are those of Jeffrey Rosenberg as of 12/11/13 and are subject to change at any time due to changes in market or economic conditions. The comments should not be construed as a recommendation of any individual holdings or market sectors.
Bonds and bond funds will decrease in value as interest rates rise and are subject to credit risk, which refers to the possibility that the debt issuers may not be able to make principal and interest payments or may have their debt downgraded by ratings agencies.