CONCERNED ABOUT RISING INTEREST RATES?
Baird Fixed Income Manager Suggests "Focus on What You Know and Can Control"
MILWAUKEE, May 22, 2013
With interest rates at historic lows, most prognosticators worry about rising interest rates in the not-to-distant future. Some suggest investors avoid bonds as even small upward changes in interest rates can have a negative total return effect on bonds.
Warren Pierson, fixed income senior portfolio manager with Baird Advisors, isn’t avoiding bonds. “It is a difficult game to try to predict interest rates and time the market. We all know rates will eventually rise, but we don’t know when. Instead of focusing on what is difficult to know and predict, we suggest focusing on what you can know and control.”
Pierson suggests a few strategies to avoid inadvertent risks in a rising rate environment:
- Avoid callable bonds – When rates rise, bond issuers are less likely to call a bond at PAR, the amount at which a bond is issued and will be paid back at maturity. These bonds will be re-priced to the longer maturity date resulting in a longer duration and more sensitivity to interest rates. Said Pierson, “Rising interest rates create a potential challenge for holders of callable bonds. Few investors are aware of the portion of their portfolio invested in callable bonds and how quickly their interest rate exposure can change.”
- Beware of extension risk in mortgages - As fewer homeowners refinance their homes in a rising rate environment, the average life of a portfolio of mortgages extends. The result is bond portfolios that will quickly price to much longer durations during a period of rising rates.
- Stick with higher quality bonds – Challenging credit conditions persist for municipal investors. Chapter 9 bankruptcies, once unheard of, are increasing and could set frightening precedents that many investors are not expecting. These potential outcomes are not fully priced into bond prices.
- Consider high quality corporates - Short and intermediate investment grade corporate bonds offer attractive alternatives to U.S. Government bonds for investors. Look for companies with steadily improving credit fundamentals and limited additional risk. Here, diversification is important to help control credit risk.
Pierson encourages investors to remember why you own bonds in the first place and keep in mind the important role bonds play in a portfolio as a diversifier and income generator. “Rising rates can have a short-term negative impact on total return, but the long run impact is a higher yield and reinvestment rate on your portfolio.”
The Baird Advisors team has always taken a duration neutral approach when managing bond portfolios. This means the duration of each portfolio is matched to the relevant index. While some managers shorten their average duration to reduce the impact of rising rates, the Baird team does not try to predict rates given the fairly low probability for active bond managers of getting the timing right. Instead the team tries to add value and control risk through careful issue selection and yield curve positioning. “Interest rates have stayed lower longer than people expected. We can’t predict when rates will go up nor do we want to try.”
To schedule an interview with Warren Pierson on this or related topics, contact Jody Lowe at (414) 322-9311 or firstname.lastname@example.org.
About Warren Pierson
Warren Pierson is Managing Director and Senior Portfolio Manager for Baird Advisors. He has over 26 years of investment experience managing various types of fixed income portfolios. Prior to joining Baird Advisors, Warren was a Senior Vice President and Senior Portfolio Manager with Firstar Investment Research and Management Company (FIRMCO) where he managed municipal bond portfolios and intermediate taxable bond portfolios. A major portion of his time is allocated to yield curve analysis and credit research. He plays a lead role in coordinating and implementing all fixed income strategy at the firm. Pierson received his undergraduate degree from Lawrence University and was awarded the Chartered Financial Analyst designation in 1990. He is currently a member of The CFA Institute and is past President of the CFA Society of Milwaukee.
Baird is an employee-owned, international wealth management, capital markets, private equity and asset management firm with offices in the United States, Europe and Asia. Established in 1919, Baird has more than 2,700 associates serving the needs of individual, corporate, institutional and municipal clients. Baird had nearly $99 billion in client assets on Dec. 31, 2012. Committed to being a great place to work, Baird ranked No. 14 on FORTUNE’s 100 Best Companies to Work For in 2013 – its tenth consecutive year on the list. Baird’s principal operating subsidiaries are Robert W. Baird & Co. in the United States and Robert W. Baird Group Ltd. in Europe. Baird also has an operating subsidiary in Asia supporting Baird’s investment banking and private equity operations. For more information, please visit Baird’s Web site at rwbaird.com.
The suggested alternative strategies may help protect principal in a rising interest rate environment and allow an investor to capture higher yields. There are risks involved with this strategy including, but not limited to, changes in interest rates, liquidity, credit quality, volatility and duration. Investments in mortgage and asset-backed securities include interest rate, prepayment, extension and default risks. Investments in non-investment grade debt securities include risks such as increased credit risk and higher risk of default or bankruptcy. Municipal bonds may be used to fund expenditures such as the construction of highways, bridges or schools. Municipal bonds are generally exempt from federal taxes and from most state and local taxes, especially if the investor lives in the state in which the bond is issued. For this reason, municipal bonds are popular with people in high income tax brackets. Some of the potential risks associated with municipal bonds include call risk, reinvestment risk, default risk and inflation risk. Additionally, it is important that an investor is familiar with the inverse relationship between a bond’s price and its yield. Bond prices will fall as interest rates rise and vice versa. Diversification does not ensure against loss and does not guarantee a profit.
For additional information contact:
Baird Public Relations