How to protect your portfolio from rising rates

  • By Lawrence C. Strauss,
  • Barron's
  • Investing in Mutual Funds
  • Market Analysis
  • Markets
  • Mutual Funds
  • Investing in Mutual Funds
  • Market Analysis
  • Markets
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  • Investing in Mutual Funds
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It’s been a tough year for income investors. Rising interest rates have pressured various types of bonds and higher-yielding stock sectors, such as utilities. In response, fund managers are favoring shorter-dated securities—and higher-quality ones too.

The Bloomberg Barclays 10-year U.S. Treasury Bellwethers index has returned -3.73% year to date through Sept. 30, and the 30-year index was off by 6.55%, according to JPMorgan Asset Management.

Also underwater over that stretch are corporate bonds, mortgage-backed securities, and municipal bonds—down 2.33%, 1.07%, and 0.66%, respectively.

Even the relatively well-performing ProShares S&P 500 Dividend Aristocrats exchange-traded fund (NOBL) has returned just 6.5% this year, trailing the S&P 500’s (.SPX) 10.9%. (The ETF tracks S&P 500 companies that have raised their dividend for at least 25 straight years.)

For some perspective as the fourth quarter gets under way, Barron’s spoke to two veteran income investors: Dan Fuss, co-manager of the Loomis Sayles Bond fund (LSBRX), and Clyde McGregor, who co-manages the Oakmark Equity & Income fund (OAKBX). The Loomis Sayles fund is up 0.72% year to date; the Oakmark fund, up 0.96%. Stocks tend to constitute about 60% of the latter’s holdings, with various fixed-income holdings making up the remainder.

“Interest rates are rising,” says Fuss, 85. “That, more than anything else, is the most important thing right now.”

The 10-year Treasury was recently yielding 3.19%, up from about 2.4% at the end of last year. But it’s still well below its average nominal yield of 6.05% since 1958, according to JPMorgan. (Bond prices and yields move in opposite directions.)

Concerned about rising rates, Fuss has positioned the $12.1 billion fund more defensively by adding a lot of holdings with shorter maturities. Shorter-dated credits help to buffer the impact of rising rates, as bonds with longer maturities will make more payments than shorter-term holdings. In theory, the present value of those future cash flows can take a big hit when rates rise. Fuss has also put more emphasis on higher-quality issues.

If rates were to rise another percentage point in a short time, longer-dated Treasuries “will probably outperform long corporates, but they will still get whacked 7%, 8%, 9%, 10%” in price, says Fuss. “That’s not good.” He also has increased the percentage of highly liquid holdings, including Treasury bills, to about 35% of the portfolio.



Two funds, two income approaches

Income investing comes in many flavors. The Oakmark fund tends to have about 60% of its holdings in stocks. The Loomis Sayles fund focuses entirely on bonds.

Fund / Ticker 1 Yr 3 Yr 5 Yr AUM (bil)
Loomis Sales Bond Fund / LSBRX 0.71% 5.05% 3.06% $12.1
Oakmark Equity & Income Fund / OAKBX 5.45 9.26 6.90 15.4

“We are waiting for rates to go higher and spreads to widen out,” he says. “We are just much more conservative.” Oakmark’s McGregor, for his part, has a value investing framework focused on “how something is priced,” he notes.

“Income has been overpriced” and “we have been defensive for quite some time, relative to duration risk,” says McGregor, 65, referring to the risk bonds face when interest rates spike.

As of June 30, Oakmark Equity & Income had about 55% of its holdings in U.S. stocks and another 6% in non-U.S equities, according to Morningstar. Another 23% was in bonds, though only a tiny sliver of those holdings were in credits with maturities of more than 10 years.

The fund’s largest stockholdings included General Motors (GM), Bank of America (BAC), TE Connectivity (TEL), and Mastercard (MA). Their respective yields were recently 4.5%, 2%, 2%, and 0.4%.

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