Speaking of Interest Rates
February 9, 2018 By Sage Advisory
When you live the life of a fixed income manager, it’s rare that a day passes without someone asking the question, “what do you think about rates?”. Rather than answer, our response typically includes our own questions that go something like this, “what rates are you referring to and where along the yield curve?”. While the Fed has a meaningful influence on short term rates, supply & demand forces cause mid & long-term rates to shift every day. Economic growth, inflation, risk appetite, and broader global monetary policy all play roles in moving rate markets. And, while the global bond market is certainly interconnected, the different fixed income market segments – Treasuries, IG Credit, High Yield, Non-Dollar, etc – will zig and zag based on fundamentals, valuations, and sentiment.
Scary headlines about how rising rates are going to devastate fixed income allocations provides a welcome opportunity to hit on some fundamental truths about fixed income:
- A ‘bad hair day’ for core fixed income is different than a ‘bad hair day’ for stocks. Yes, a big move higher in long Treasuries will hurt if your’ portfolio consists of 100% long Treasuries. Properly diversified fixed income allocations typically weather rate volatility just fine.
- As fixed income investors, we want rates to rise. We just want it to happen slowly and for policy changes by the Fed to be well telegraphed. But, like the Rolling Stones said, you can’t always get what you want. The key for fixed income investors is to stay diversified, stay within policy, and most importantly know what you own.
- In addition to the well documented diversification benefits, nothing replaces the utility function of fixed income. For clients who have a known liability, cash flow, or purpose for their investment portfolio, a properly structured fixed income allocation can address the utility with a high degree of certainty and relative safety.
So are higher rates a good thing? They certainly have been for cash investors, though it’s unclear how many people are paying attention. Following the 2016 regime change in Washington, short-term interest rates jumped substantially. The 2-Year US Treasury Note increased from 1.20% to 2.16% over the last 13 months (as of 1/31/18). To put that move into context, the 10-Year Treasury traded through 2.16% this time last year. Today, a typical Government Money Market Fund yield is close to 0.80%, a typical Prime Money Market Fund yields around 1.10%, and the custom Cash Management SMA Sage manages yields approximately 2.20%. Not only does this give institutions the opportunity to earn more on their cash, they also have differentiated investment options to consider. We recently published a white paper on the topic of Cash Management if you want a bit more fixed income nerdiness in your life.
Source: Bloomberg, Morningstar Direct. This is for informational purposes only and is not intended as investment advice or an offer or solicitation with respect to the purchase or sale of any security, strategy or investment product. Although the statements of fact, information, charts, analysis and data in this report have been obtained from, and are based upon, sources Sage believes to be reliable, we do not guarantee their accuracy, and the underlying information, data, figures and publicly available information has not been verified or audited for accuracy or completeness by Sage. Additionally, we do not represent that the information, data, analysis and charts are accurate or complete, and as such should not be relied upon as such. All results included in this report constitute Sage’s opinions as of the date of this report and are subject to change without notice due to various factors, such as market conditions. Investors should make their own decisions on investment strategies based on their specific investment objectives and financial circumstances. All investments contain risk and may lose value. Past performance is not a guarantee of future results.
Sage Advisory Services, Ltd. Co. is a registered investment adviser that provides investment management services for a variety of institutions and high net worth individuals. For additional information on Sage and its investment management services, please view our web site at www.sageadvisory.com, or refer to our Form ADV, which is available upon request by calling 512.327.5530.