Rising Yields: Implications For Investors

With an on-going debate on how quickly the Federal Reserve will taper its bond purchases, investors have finally begun to worry about rising bond yields. We look at some of the implications for investors.

Author : iFAST Research Team KEY POINTS: Longer-dated bond yields have spiked in recent weeks, possibly in anticipation of lowered levels of asset purchases The Fed may soon “taper” its bond buying programme for several reasons; the US economy appears to be healing, while a lower projected federal budget deficit should mean lower Treasury issuance, leaving the Fed with fewer bonds to buy Historically, rising longer-dated bond yields have had a differentiated impact on the various asset classes; stocks and high yield bonds have tended to fare better, while safer bonds and yield-sensitive assets have tended to underperform A key fundamental reason why stocks have been sold off in anticipation of higher interest rates is the rising “discount” rate; with a higher risk-free rate, investors require a better return on equity investments to compensate for the higher risk Still, investors have been fairly indiscriminate in their selling of stocks, with stock markets seeing a fairly high level of correlation; both expensive and cheap markets have been sold off Our valuation-driven approach sees us favouring markets with more-attractive valuations, which we feel should allow these markets to deliver outsized returns going forward; in theory, this “margin of safety” should minimise the effect of a rise in the risk-free rate Continue to underweight fixed income; we maintain our preference for shorter-duration lower-risk bonds while avoiding longer duration debt which carries more interest rate risk Despite the poor recent market performance, some positives can be identified; the Fed’s intention to “taper” asset purchases comes on the strength of the US economy, which should continue to be a positive for risk assets Also, the indiscriminate nature of the sell-off should allow value-focused investors to better position their portfolios in more attractively-valued markets; a normalisation of valuations in some of the more expensive markets could make them more compelling investments again Source: Fundsupermart