Rising rates and short-term volatility

Marina Evtimova
Marina Evtimova, BlackRock's EMEA
Portfolio Analysis & Solutions team

Exploring possible ways to navigate the new fixed income environment through Bond ETFs

Capital at risk. The value of investments and the income from them can fall as well as rise and are not guaranteed. You may not get back the amount originally invested.

Rates on the move: Time to pay attention?

After 30 years of a global bond bull market, the investment environment has changed. While many market participants might have limited experience with a rates hike cycle, the quantitative tightening of the Fed is a journey into the unknown for all. In 2018 we witnessed 4 rate hikes and significant market volatility. In 2019 we might see a change in the Fed’s rate hike pace off the back of potential global growth slowdown pointing to a lot of uncertainty in markets ahead of us.

Is cash an answer to a rising rates environment?

A key concern in a rising rates environment is minimising portfolio losses. A de-risking strategy for investors in such a scenario could be to move into cash. However, this investment decision might result in missed return opportunities and reduced portfolio diversification. The BlackRock Portfolio Analysis and Solutions team has stress tested investors’ portfolios to showcase the power of remaining invested through different strategies, depending on investors’ objectives and risk appetite.

No one size fits all...

Investors need different portfolio solutions at various stages of a rates hike cycle. Anticipating these needs and the different constraints faced is key to helping them build better portfolios. The BlackRock Portfolio Analysis and Solutions team can help investors navigate the changing world of fixed income by designing solutions to help prepare portfolios for three market scenarios:

  1. Short term: Rising rates and flattening of the yield curve
  2. Medium term: Fixed income re-pricing
  3. Long term: An uncertain future

Rising Rates – A new world order

In this video we look at three possible market scenarios for 2019 and ways investors can build resilience into their fixed income portfolios using bond ETFs.

Scenarios to prepare for, as rates rise

The Scenario

1. Rising rates and short
term volatility

As Central Banks prepare to hike rates and tighten their balance sheets, investors need to manage short term risk until the banks’ forward guidance and market expectations align

2. Fixed income re-pricing

As Central Banks and markets are aligned, investors need to seek new investment opportunities

3. An uncertain future

Looking at the next 2-5 years, there are still unknowns and corresponding scenario uncertainties in fixed income – portfolios need to be structurally prepared for potential rainy days

Strategy

1. A place to hide

Minimise portfolio losses without moving into large cash positions through either:

  1. Rotating into ultrashort duration and floating rate exposures
  2. Rotating into interest rate hedged exposures

2. Looking for a sweet spot

Reposition for the re-pricing through either:

  1. Rotating into shorter duration credit strategies
  2. Rotating into floating rate exposures

3. Portfolio diversification

Remain flexible and outcome oriented in your fixed income allocations while managing markets’ vs policy makers’ forward guidance misalignments

Example Period

sept '17 - feb '18

During the period Sept 2017-Feb 2018, this scenario materialised for investors in the US market

feb '18 - apr '18

During the period Feb-Apr 2018, this scenario materialised for investors in the US market

2 - 5 years

Considering the next 2-5 years, a lot of unknowns remain which might require structural portfolio changes

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1. Portfolio Solutions: Short Term

Assessing the ex-ante portfolio P&L of a US investors average allocation vs 4 portfolio solutions during the period Sept 2017-Feb 2018 shows that a rotation from longer dated bonds into ultrashort duration, floating rate or interest rate hedged bond exposures could offer more downside protection than moving into cash

2. Portfolio Solutions: Mid Term

Assessing the ex-ante portfolio P&L of a US investors average allocation vs 4 portfolio solutions during the period Feb 2018 - April 2018 shows that moving into short dated investment grade or high yield corporate bond exposures could still provide attractive downside protection while helping diversify the sources of return in the portfolio

3. Portfolio Solutions: Forward looking

Whether looking to minimise interest rate sensitivity or maximise income, when constructing optimal portfolios, investors could achieve better risk-adjusted outcomes by blending inflation linked, floating rate, short dated investment grade or high yield corporate bond exposure and remain flexible in their asset allocation while rates normalisation continues

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