Fixed Income is the Portfolio’s “Boring Backbone”Sheaff Briefs Editor
Should bonds continue to be included in investment portfolios even when interest rates are expected to rise? Most definitely, Oppenheimer Asset Management’s Managing Director Leo Dierckman told our SheaffBriefs editor.
In fact, Dierckman went on to say, bonds serve as the backbone of both individual and institutional portfolios, offsetting the risks of equity and alternative investment holdings, and reducing volatility. Using an analogy from baseball, Dierckman cautions investors that bonds can reasonably be expected to deliver “singles” and “doubles,” rather than home runs.
“When rates in the marketplace rise,” writes Daisy Maxey in the Wall Street Journal, “the prices of older bonds with lower rates fall. But over a period of years,” she explains, “bond investors will do better in an environment of rising interest rates than in one in which rates stay at today’s unusually low levels.”
Dierckman agrees. Interest rates tend to rise when the economy is improving, he explains, and those same forces improve corporate credit, thus reducing the credit risk inherent in bond portfolios.
In what he and others, including the Federal Reserve, dubs our New Normal investment climate, Dierckman is proud of Oppenheimer’s “boring fixed income” management style, which avoids embellishments such as derivatives that can add risk and volatility to bond holdings and instead emphasizes a combination of investment grade and high yield corporate bonds along with Treasuries to assist in managing duration. “We encourage investors to take risk,” Dierckman says, “but not on the fixed income side where the compensation for taking risk at this time is not justified.”
In fact, the two elements of risk that must be managed in fixed income investing are duration risk and credit risk. Bond investors can potentially do better when interest rates are rising rather than in today’s market when rates stay at unusually low levels, Dierckman explains, finding the most attractive risk/reward profiles in bonds with three to seven year maturities. Managing credit risk also helps reduce interest rate risk; the corporate debt is less reactive to rising rates and helps level out the greater impact rising rates have on Treasuries. The Efficient Frontier concept of achieving the highest expected return for the lowest possible risk applies here: a combination of assets will tend to outperform monochromatic portfolios over time, and with less volatility.
Should bonds continue to be included in investment portfolios? Leo Dierckman’s message to Sheaff Brock investors when he is guest speaker at the special November Knowledge Builder webinars on the dynamic relationship between interest rates and your bond portfolio is likely to be “Most definitely”!