Outside voices and views for advisers

The downsides of laddered bond portfolios

Why bond laddering isn't the solution to a rising rate environment

Jul 15, 2014 @ 7:13 am

By Terry Hults

+ Zoom

We think investors who build laddered portfolios to protect against rising rates will be disappointed — by locking in low yields with traditional ladders or by hidden risks of higher-yielding ladders. In our view, actively managed portfolios are better able to take advantage of changing markets.

Laddered portfolios are built with bonds spaced evenly across maturities so that bonds mature and their proceeds are reinvested at regular intervals. These portfolios are assumed to be simple, provide return certainty and capture higher yields as interest rates rise.

They're definitely simple, and they do provide a relatively certain return. But in today's low-yield environment, that return is likely to be locked in at below-inflation yields for the next few years. A portfolio laddered from one to 10 years yields only about 1.5 percent before accounting for the costs of trading and other annual fees. At that low yield, there's little chance to beat even a modest rate of inflation.

To improve yield in a low-rate environment, laddered portfolios sometimes include longer-maturity bonds, which increase their interest-rate risk; or portfolios include lower-credit-quality bonds, which increase credit risk. In our view, neither approach is advisable in a passive portfolio. Putting money into the riskiest parts of the bond market, without the ability to monitor and manage those risks, jeopardizes the value of what investors often consider the safest part of their portfolio.

Another way laddered portfolios sometimes seek to boost yield is by eliminating short-term maturities — shifting to a five- to 15-year ladder, for example. However, this strategy virtually eliminates the benefits of reinvesting when rates rise: Investors have to wait five years until the shortest bond matures before reinvesting. In effect, it puts the portfolio on hold for five years.

Yield Isn't the Only Source of Return for Actively Managed Portfolios

When interest rates rise, a passively managed laddered portfolio has to wait until a bond matures to reposition and capture higher yields. In a 10-year ladder, for example, the investor owns a 10-year bond, a nine-year bond and so on, all the way down to a one-year bond. When the one-year bond matures, the investor can buy a new 10-year bond. But until that one-year bond matures, the only thing to do is wait—and maybe miss out on taking advantage of interest-rate fluctuations in the meantime.

While a laddered portfolio's return comes largely from yield, actively managed portfolios can access other sources of return. Given today's steep yield curve, returns can be bolstered with “roll” — he tendency of bonds' values to increase as they move closer to their maturity date. Active managers can seek to profit by buying bonds with high roll returns and selling other bonds whose values are likely to fall as they approach maturity. Right now, the potential return from roll in the intermediate part of the yield curve seems especially high — in some cases, adding almost 2 percent to a bond's additional return potential above its yield.

The simplicity of laddered portfolios is appealing. Unfortunately, in return for simplicity, an investor either 1) locks in historically low yields and is likely to lose money after accounting for inflation over the next couple of years; or 2) increases his yield and takes on risks that should be actively managed.

In the end, we think investors can earn more after-tax income and total return by stepping off the bond ladder and placing their bond portfolios in the hands of an experienced active manager.

Terry Hults is a portfolio manager, municipal investments at AllianceBernstein

The views expressed herein do not constitute research, tax advice, investment advice or trade recommendations and do not necessarily represent the views of all AllianceBernstein portfolio-management teams. Past performance of the asset classes discussed in this article does not guarantee future results.


What do you think?

View comments

Recommended for you

Sponsored financial news

Upcoming Event

Jun 27


Emerging Market Debt: 5 Forces at Work

When it comes to emerging market debt, there are a series of forces that help you drive better results for your clients. In today's continually changing market environment, it is critical to know the forces at play to help keep your investment... Learn more

Accepted for 1 CE Credit from the CFP Board. Approved by IMCA for 1 CIMA®/CIMC®/CPWA® CE credit. Approved for 1 CFA Credit.

Featured video


Building digital relationships with a human touch

The word "robo" has stopped being a four-letter word for financial advisers. But how can it be an asset? Quovo's Jeff Hendren explains.

Video Spotlight

Will It Last As Long As Your Clients Do?

Sponsored by Prudential

Video Spotlight

The Catalyst

Sponsored by Pershing

Latest news & opinion

Brian Block's $4 million bonus was tied to a key metric at ARCP

Prosecution rests case in fraud trial against CFO of American Realty Capital Properties.

Edward Jones is winning the Google search war

Brokerage firm's digital marketing investment helps land it at the top of local and overall search engine results, report finds.

Voya's win in 401(k) fee suit involving Financial Engines bodes well for other record keepers

Fidelity, Aon Hewitt and Xerox HR Solutions are currently defending against similar fiduciary-breach claims.

Collective investment trusts getting more attention from 401(k) advisers

The funds are catching on due largely to lower costs and more product availability, but come with some inherent drawbacks.

Vanguard rides robo-advice wave to $65B in assets

Personal Advisor Services, four times the size of its closest competitor, combines digital and human touch.


Subscribe and Save 60%

Premium Access
Print + Digital

Learn more
Subscribe to Print