Protecting capital in a rising interest rate environment


As the saying goes ‘All good things must come to an end’.

History dictates that interest rates will not stay low forever, but the speed at which rates rise and how far up they climb is difficult to predict. Those who pay no attention to interest rates can miss out on valuable opportunities to profit in a rising rate environment.

This is why investors, especially ones who have high bond allocations, need guidance on how to best position their portfolios in an environment where interest rates are moving upwards.

The Lens offers some thoughts based on our team’s conversations with asset managers and investors.

For starters, investors might consider a more flexible, opportunistic bond portfolio with the ability to allocate an amount of risk to the most attractive opportunities available in the global fixed income market. This gives the flexibility for material shifts in sector allocations as market conditions change in the longer- term.

And much has been spoken about duration. Shortening duration can of course make a portfolio less sensitive to rising interest rates – but if rates stay at current levels for longer than expected, a shorter-duration portfolio sacrifices yield for safety and will generate less income and become more costly over time. Therefore, duration timing is a problem, though strategies exist to hedge duration risk and reduce the impact of rate moves.

Investors could also consider diversifying into other asset classes, such as investing in a multi-asset strategy that allows portfolio managers to optimise risk/return profiles.

And what about moving part of a bond allocation to equities? Dividend-paying stocks, REITS and preferred equity – there are opportunities to find less interest-rate sensitivity here.

Commodities and private equity, meanwhile, offer lower correlations with traditional assets.

Rising rates do not necessarily mean negative total returns. However, whilst risk appetites may differ between investors, having a better understanding of the opportunities available and the different levels of risk inherent in various asset classes will help them position portfolios to help mitigate the impact on total returns.

All good things must come to an end, sure. But there’s no reason why the end has to be a bad one.