Why invest outside the index? We believe that's where today's best opportunities are.
For more than 25 years, declining interest rates have driven prices in the bond markets higher, leading to strong returns for investors. But with interest rates today near their all-time lows, investors can't count on further declines to drive future returns.
What happens when interest rates rise?
Bond prices and interest rates generally move in opposite directions – when rates rise, the value of existing bonds declines. The degree of a bond's sensitivity to those interest-rate changes is measured by duration. Expected volatility in rates poses trouble for duration-orientated bond indexes. See how some of Putnam strategies have reduced this risk.
Because today's low rates offer so little income to offset any price declines, even a small increase in rates could lead to significant losses for certain types of fixed-income securities.
Sources: U.S. Department of the Treasury, Federal Reserve, as of 12/31/13.
For every 1% change in interest rates, a bond's price is expected to move 1% in the opposite direction per year of duration. In other words, the higher a bond's duration, the more sensitive it is to interest-rate movements. For investors who own individual bonds and are willing to hold them until maturity, duration may not be much of a concern. But investors in a government- or index-oriented portfolio who need even a small degree of liquidity should pay careful attention to the level of interest-rate risk they're assuming.
Sources: U.S. Department of the Treasury, Barclays, Putnam Research, as of 6/30/13. ?The Barclays U.S. Aggregate Bond Index is an unmanaged index of U.S. investment-grade fixed-income securities. You cannot invest directly in an index. For illustrative purposes only. Performance of Putnam funds will differ.