Fixed income flashback: is history going to repeat?
Traditional financial theory portends that bond prices fall when interest rates rise. Yet, a bond’s total return comprises not just price changes, but also income. This is important because, as rates rise, the income on a bond can help offset falling prices, cushioning the overall total return.
For investors, the relevant questions are:
- How much will the price fall?
- Is there enough income to offset the price decline?
Low bond yields have driven a search for yield but also have fixed income investors concerned about rising interest rates and the effect on their portfolios. Many are cautious in choosing fixed-income investments given the potential for interest rate increases as economies continue to expand. However, rising rates do not necessarily mean negative total returns. While rising rates adversely impact bond prices, various sectors of the fixed income market respond differently and active portfolio management can help mitigate the impact on total returns.
So how can investors best position their portfolios for a rising rate environment? The answer starts with understanding the relationship between interest rates and fixed income returns.
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