With the Fed poised to continue hiking interest rates through the end of the year to combat inflation, many investors are worried about the potential impact on their investments.
FlexShares’ research into the past four Fed rate hike cycles (2015, 2004, 1999, and 1994) suggests that high yield bonds may be well positioned for stronger returns during rising rate environments.
The FlexShares High Yield Value-Scored U.S. Bond Index Fund (HYGV) offers exposure to high yield bonds screened for value and quality for just 37 basis points.
“Because rising interest rates hurt the prices of existing bonds, investors are likely to focus on the potential interest rate risk in their fixed-income allocations,” FlexShares wrote in an insight. “During Fed tightening cycles, the market has historically anticipated rate increases and prices them into the bond market before they happen.”
However, according to FlexShares, there is always uncertainty about the timing, size, and number of rate hikes, which may create additional volatility if actual rate hikes don’t match the market’s expectations.
Investors can address this uncertainty by managing the duration in a fixed income portfolio. According to FlexShares’ research, duration is responsible for the majority of expected returns in fixed income assets, and bonds with shorter durations are often less sensitive to rising interest rates.
While shorter-duration bonds can help reduce risk, they generally come with lower yields, which may not align with investors’ income goals. Investors can boost their portfolios’ yield by taking on additional credit risk.
High yield bonds outperformed equities during the Fed rate hiking cycles of 2015 and 2004, delivering one-year returns of 12.1% and 10.3% versus equities’ 7.7% and 8.7% returns, respectively. according to FlexShares.
HYGV can be an ideal product for investors looking to add income while avoiding some of the riskiest junk debt, according to the ETF Database.
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