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Interest rate rises: how investors can protect bond portfolios

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Market expectation that the US and UK will raise interest rates later this year has already led to increased volatility in the bond market. How can investors plan ahead?

For the first time since the financial crisis of 2008, the policy of Central Banks is set to diverge. The US Federal Reserve and the Bank of England are expected to raise interest rates and tighten monetary policy. While the ECB and Bank of Japan are loosening monetary policy, having just begun or are expanding their quantitative easing programme.

In response, Adrian Lowcock, head of investing at AXA Wealth, offers investors three ways to protect bond portfolios.

  • Be Flexible

There is little to be gained investing in benchmark constrained funds or index trackers which will buy or sample the whole market.  Investors need a fund which can protect against rising yields and avoid the areas of the market most sensitive to interest rate rises.

  • Be Diversified

Don’t just own a total return bond fund which invests only in traditional bonds, ensure your bond fund is fully diversified across many markets and is not closely correlated with traditional bond indices.

  • Mitigate Losses

Bond managers can use hedging and portfolio management to reduce risk of a loss. Investing in derivatives in the bond market provides exposure to investment strategies which can provide a positive return whether the market falls or rises.

Two funds, which can be used to protect bond portfolios in a volatile market

  • Blackrock Fixed Income Global Opportunities 

Manager Scott Theil’s fund is not constrained by benchmarks, running an unconstrained fund which is well diversified across sectors.  The fund is managed with strict risk controls and targets a total return, so the income generated on the fund may vary.  The current yield is 0.79 per cent.

  • Artemis Strategic Bond

Manager James Foster’s focus is very much on the macroeconomic factors such as interest rate movements and inflation. Combined with analysis of specific bonds credit worthiness determines his asset allocation decisions. The current yield is 4.6 per cent.

The divergence in central bank policy is going to create volatility and opportunities for investors as well as risks.

Market expectations that the Fed will raise interest rates later this year, with the UK following suit has already led to increased volatility in the bond market.

Investors need to be cautious with their exposure to the bond market, after a 30 year bull run and record low interest rates it has become more difficult to get a decent interest; the risks of achieving a 5 per cent return, once the expected normal yield, have risen 4 fold following the financial crisis. Bonds are no longer the lower risk asset class and investors could loss significant sums of money.

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