Open up the business section or watch business TV and you are sure to find something about the federal reserve and “tapering.” Everyone keeps talking about it, but what is it and how can you adjust your investment portfolio to prepare for it? Those focused on retirement investing should pay close attention, as it will impact you the most.
In layman’s terms, tapering is the slowing down — and eventual ending — of the massive Federal Reserve stimulus program that’s been aimed at getting the U.S. economy back on a solid growth track. The huge bond purchases of $85 billion a month have kept interest rates at historically low levels. The unintentional impact of this was that stock markets screamed higher as investors had nowhere else to generate any yield.
Retirees, who had grown comfortable watching the value of their U.S. bond holdings rise on each monthly statement over the course of decades, suddenly reacted in horror as their June and July statements arrived in the mail, showing steep losses in almost all fixed income classes. For retirees looking for fixed income, this is serious. What should they do?
Here are two sectors of the fixed income market that investors may want to seek out in a rising rate environment:
Global Non-U.S. dollar bonds
This is an asset class that is foreign to many investors, no pun intended! Believe it or not, investing in foreign bonds provides both value and stability. It’s all about the business cycle.
Alison Martier, senior portfolio manager of fixed income at AllianceBernstein, writes:
A U.S.-only bond investor is affected by one business cycle, one yield curve, and a single monetary policy. As long as rates were falling, that seemed like a good thing. Not so these days. Going global diversifies an investor’s interest-rate risk — and brings many other potential benefits. Although different countries’ economic cycles, business cycles, monetary policies and yield curves may briefly align, over long periods they’ve not been highly correlated.
While we may think foreign bonds are speculative and very volatile, they surprisingly are not. According to Douglas Peebles, chief investment officer and head of fixed income at AllianceBernstein, “in adverse bond markets…there has historically been a greater performance gap, with global bonds faring significantly better than U.S. bonds. While U.S. bonds declined 1.1 percent on average in down quarters, global bonds lost only 0.7 percent. That’s 62 percent of the downside of U.S. bonds — a significant advantage.”
Senior Bank Loans
According to Gary Gordon of ETFexpert.com, “senior bank loans are floating-rate securities from below-investment grade companies.” Unlike “junk bonds,” he added, these debts are given seniority over other creditors and have been secured by collateral such as real estate.
“Better yet, since the debt ‘floats’ over short time periods, prices and yields can rise alongside interest rates,” Gordon wrote.
Attesting to their relative safety, Timothy Strauts of Morningstar writes on Seekingalpha.com, “bank loans have tended to have low average default rates versus high-yield bonds.”
This means that since the securities are below investment grade, you get higher yields, a decent degree of safety, and since they are floating rate, they can shoot off higher yields as rates rise.
It is important to note that past performance is no indication of future results, and with all of these options there is the potential to lose money. It may pay to speak with a financial professional who has experience with these assets to see how they can be incorporated into your retirement portfolio.