Interest rates are on the rise, but the amount of fear circling bond funds is overblown, according to Joanna Bewick, portfolio manager of the Fidelity Strategic Asset Allocation Funds.
The reason investors shouldn't be overly concerned about their bond portfolios today is that there aren't any near-term catalysts that could send interest rates soaring and cause big losses in bond funds. The main drivers of interest rates — economic growth and inflation — are likely to stay muted, and the U.S. Federal Reserve, which is buying $85 billion in government debt and mortgages a month, isn't going anywhere, Ms. Bewick said at a press conference in New York yesterday.
“We could be in this Goldilocks environment for some time,” she said.
Ms. Bewick's cautioning coincided with the 10-year Treasury ending the day with a yield above 2% for the first time since mid-March. It fell as low as 1.66% at the beginning of May.
Investors increasingly have been hedging their bets against rising interest rates. The average monthly inflow into intermediate-term-bond funds has dropped by 71% over the past three months, according to Morningstar Inc.
Flows into bank loan funds, nontraditional bond funds and global bond funds, which all promise protection against rising interest rates, have spiked. Nontraditional bond funds, which can go both long and short the bond market, have average $4.2 billion of inflows a month, up from $486 million a month in 2012, according to Morningstar.
Even with interest rates moving up, Ms. Bewick doesn't see bonds' worst case scenario coming true, which would be a repeat of 1994, when the Fed unexpectedly raised interest rates 300 basis points during the course of the year and caused the
Barclays Capital U.S. Aggregate Bond Index to lose 2.9%, one of only two years the benchmark index of bonds declined since 1976.
“I have a hard time seeing a 1994 scenario today,” she said. “Fear's overblown in the bond market. There will be headwinds, but not a disaster.”
However, just because there won't be a disaster doesn't mean advisers should be expecting returns to match what they've been in the past.
“What you get from bonds today are coupons,” Ms. Bewick said, noting the premiums at which most bonds are trading today.
High-yield bonds, for example, are now yielding below 5% for the first time ever. The spread over Treasuries remains around 400 basis points, though.
Treasuries remain the most sensitive to interest rate movements, but even with yields as low as they are, Ms. Bewick still sees a place for them in a portfolio.
“High-quality debt is becoming scarcer,” she said. “I don't like the valuations, but I sure do like capital preservation. You need a place to hide when volatility spikes.”
