Key takeaways for your client conversations
Common bond benchmarks could see volatility like 2013's "taper tantrum" again.
Investing for income will be challenged as the Fed moves rates higher.
It is possible to navigate rates by maneuvering outside common indexes.
Bonds attract investors as a source of income and a refuge from the volatility of stocks. But these qualities should not obscure the fact that as bond yields have fallen, interest-rate risk has increased in the Barclays U.S. Aggregate Bond Index, a major benchmark.
As a result, typical portfolios pursuing income with benchmark-aligned strategies may be less safe than many people think. In 2013, when Fed policy makers merely revealed a discussion of "tapering" the central bank's quantitative easing program, the Barclays U.S. Aggregate Bond Index delivered its first negative annual result in more than a decade, returning -2.02%. And, today, interest-rate risk in the index is just as high — if not higher — than in 2013.
How to outmaneuver rate risk
Investors have an alternative to invest outside of indexes and consider security types that are not overly subject to the risk of rising rates. When we consider such non-Aggregate sectors of the bond market, the "spread" — or difference in yield between a given sector and U.S. Treasuries of equal maturity — highlights several areas of potential opportunity. Spreads today in some sectors are higher than their long-term averages leading up to the financial crisis. Of course, it takes resources to conduct careful research in out-of-benchmark sectors, but it is one way to position a portfolio to be prepared for rising rates.