Over the years of this blog I’ve written about two specific solutions for a fixed income portfolio. Specifically I’ve been a believer of owning small slices of various fixed income segments including foreign, preferred stocks, mortgage, inflation protected and several others while avoiding the most overpriced segment which I believe is US treasuries. Treasuries have been expensive for a long time, have continued to get more expensive and could continue to go up in price but buying high is still buying high and that is usually a bad idea. To the extent you are interested in a fund that would do this for you, the terms that has come into play here are multi-sector and unconstrained. Obviously there are plenty of funds within each individual segment to explore.
One segment that has attracted assets in the last few years are floating rate loan fund. The basics are simple; the loans tend to be lower rated or unrated with appeal being that the rates adjust with the market, usually every three months. So as prevailing rates go up then rates charged to borrowers (loans made by the fund) also go up. While there is still credit risk, interest rate risk should be off the table and of course we are focusing on in this post is interest rate risk.
I think there will be a lot of product development in the realm of strategies to help deal with rising rates. Recently I have started to learn more about negative duration. There are already several ETFs in the market place that strategically create a negative or zero duration. In a normal bond portfolio you have some duration which is similar to maturity although duration is a more accurate measure of the average length of your bond portfolio.
The biggest bond funds all have positive durations and the number is easily found on the info page for a given fund. You might see a duration of five point something years on a fund tracking the Aggregate Index but whatever the number, if positive, it will take on some amount of interest rate risk. Low and negative duration funds are likely to grow in popularity because there will be increased need at some point for increased bond portfolio protection.
It is important to realize that the planet will not stop rotating on its axis if ten year yields trade in line with the historical average of 6% (per Barron’s) but the path to 6% will be very painful for a lot of bond portfolios.
This article was written by AdvisorShares ETF Strategist Roger Nusbaum.