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  • Bonds Can Still Perform when Interest Rates Rise

    rising interest rates and bonds

    At Hennion & Walsh, we believe bonds offer income-oriented investors a reliable stream of income and protection against fluctuations in interest rates when held to maturity. Bonds, including Municipal, Government, or Corporate bonds, can also offer compounded growth opportunities when investors reinvest the income they receive from the bonds.

    Additionally, for growth-oriented investors, fixed income securities can provide investors with downside protection and diversification within a growth portfolio, especially in a highly volatile market where additional, measured, short-term flights to quality are likely.

    Understanding Interest Rate Changes and Bond Investments

    In our view, investors should be careful not to miss out on the income and diversification opportunities offered by bonds by trying to time future, potential changes in interest rates.  History has shown us that trying to time the market, or time interest rate increases or decreases, is often an exercise in futility.   With this said, it is important to understand that when interest rates do increase, bond prices may fall and yields may rise.

    However, rising interest rates should not impact the interest that bond holders receive on their bond holdings nor should they change the ability of these investors to receive par value on their bond holdings at maturity. Bond fund investors, on the other hand, may see the interest they receive on their fund holdings change in a rising rate environment and will not receive a fixed value at maturity as there generally is no set maturity on bond funds.

    Analyzing Previous Rate Hike Cycles

    However, recognizing, of course, that past performance is not an indication of future results, history has shown that certain fixed income asset classes have weathered previous periods of tightening.   Nuveen Asset Management’s research (see below) analyzed three of the most recent rate hike cycles to assess the performance of different types of bonds during these specific periods of tightening.  These time periods were as follows:

    • February 1, 1994 – February 28, 1995
    • June 1, 1999 – May 31, 2000
    • June 1, 2004 – June 30, 2006

    A review of this data shows that various fixed income asset classes have provided positive performance results during previous periods of rising interest rates – some better than others.

    Rising Rates Asset Class Performance incl Bonds

    SourceNuveen Asset Management, “Market Commentary:  Fixed Income in a Rising Rate Environment”, June 2015.  Data provided by Morningstar Direct.  Fixed Income asset classes displayed in the chart are represented by their relevant indexes.  A list of these indexes can be provided upon request.  The Securitized Debt asset class is represented by Barclays Capital Mortgage-Backed Securities Index due to limited track record of the Barclays Securities Debt Index.  Market indexes do not include fees.  You cannot invest directly in an index.  Past performance is not an indication of future results.

    Anticipated Pace of Rate Hikes

    We anticipate this period of tightening on the part of the Federal Reserve (“Fed”) to exhibit a similar gradual and extended pace of rate hikes that we saw during the 2004-2006 time period.  During this time period, the Fed raised the Federal Funds Target Rate seventeen times in 25 Basis Point (i.e. 0.25%) increments.  As a result, an initial 25 Basis Point in December (which many now believe is highly likely) should not have a significant short term impact on bond pricing, and is likely already priced into the market.   Looking out further to the intermediate term, gradual rate hikes should likely only have a gradual impact on bond prices as well.

    While allocations to bonds may vary based upon market conditions as well as investor objectives and risk appetites, certain types of bonds, from certain types of issuers, can still find a home in most investment portfolios throughout most market cycles.

    DisclosureThe article above is for informational purposes and is not an offer to sell or a solicitation of an offer to buy any of the themes or securities discussedHennion & Walsh Asset Management currently has allocations within its managed money program and Hennion & Walsh currently has allocations within certain SmartTrust® Unit Investment Trusts (UITs) consistent with several of the portfolio management ideas for consideration cited above.

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