Home' Trinidad and Tobago Guardian : September 20th 2015 Contents 10SBG STOCKS
SUNDAY BUSINESS GUARDIAN www.guardian.co.tt SEPTEMBER 20 • 2015
Relief washed over the bond
market this week after the
Federal Reserve decided to
hold off on hiking interest
rates. But many investors were
left to wonder: was it just a
The stakes are high for bond mutual funds,
which are supposed to be the safe part of our
portfolios. Investors have been fretting for
years that interest rates are set to rise, some-
thing that would knock down bond prices.
And even though the Federal Reserve didn t
raise its benchmark for short-term rates this
past week, the majority of its policymaking
committee still expects it to happen later this
Even so, bond funds can still be a shock
absorber, offering some stability when the
stock market goes on another of its dizzying
drops, fund managers say. They re looking to
offer reassurance following predictions for big
losses for bonds. There s just one caveat that
even the most optimistic manager acknowl-
edges: Bond funds won t do as good a job as
in prior years, because they re paying much
less in interest.
"I don t think it s going to be Armageddon"
when the Federal Reserve does hike interest
rates, says Jim Kochan, chief fixed-income
strategist for Wells Fargo Funds Management.
"It s a healthy move away from zero."
Why rising rates are a fear
When interest rates rise, demand for existing
bonds falls because their yields suddenly look
less attractive. That makes their prices drop.
To see what rising rates can do to bond
mutual funds, look to 2013, when the yield
on the 10-year Treasury nearly doubled in
eight months. The average intermediate-term
bond fund lost 1.4 per cent.
Investors can insulate themselves by buying
individual bonds and holding them until matu-
rity. That way, even if the market price drops
for a bond, they won t necessarily feel it. But
they would lose out on the extra income that
a new, higher-yielding bond would have pro-
vided. Plus, most investors prefer a diversified
fund portfolio of thousands of bonds.
Why bond funds can avoid
The Federal Reserve controls interest rates
for very short-term loans, ones that banks
make to each other overnight. It has less control
over longer-term interest rates.
A big factor influencing 10-year Treasury
yields is where inflation and economic growth
are heading, and neither looks all that strong.
That should help limit the rise of longer-term
rates, fund managers say. The largest category
of bond funds focuses on those maturing in
four to 10 years.
Several factors are keeping inflation low,
including the plummeting price of oil and the
scarcity of pay raises for many workers. Global
economic growth is also under pressure as
China s gains slow sharply, while Europe and
Japan struggle to kick start theirs.
Add that together with the slow, steady pace
that the Federal Reserve has promised for
short-term interest rates, and fund managers
expect longer-term interest rates to rise mod-
estly and gradually.
In that scenario, bond funds could avoid
losses. Their price will drop as interest rates
rise, but the income they produce could help
offset the declines. And the income could be
reinvested in higher-yielding bonds.
Why expectations have to be
lower than before
Bond funds have historically helped give a
sense of security when the stock market plum-
mets. During the 2008 financial crisis, the
largest category of stock funds lost 37.8 per
cent, while many bond funds posted gains.
And among funds that lost money, bond
funds generally had more modest losses than
stock funds. The average intermediate-term
bond fund had a loss of 4.7 per cent that year.
But bonds were producing much more
income then. The 10-year Treasury yield is
2.15 per cent today, down from 4.0 per cent
at the start of 2008, which means bond funds
will likely provide less protection in the next
steep decline for stocks.
Other concerns also linger
Even if longer-term rates rise only modestly
in coming years, they can still have quick jags
up and down as the Federal Reserve returns
rates to more "normal" conditions. That means
bond funds likely won t have the same placid
returns as in prior years.
The Federal Reserve has kept short-term
rates at their record low of nearly zero since
2008, and the last time it raised rates was
nearly a decade ago. That means bond traders
with several years experience were barely in
high school the last time the Fed hiked rates.
Numbers to consider
When choosing a bond fund, pay attention
to its "duration." That number shows how
sensitive a fund is to changes in interest rates.
The largest bond fund by assets has an aver-
age duration of 5.7 years, which roughly means
that an immediate, one percentage point rise
in interest rates would lead to a 5.7 per cent
drop in price. Short-term bond funds will
have shorter durations. AP
What's next for bond funds
after the Fed's decision?
File photo: In this Monday, August 24,
2015, file photo, pedestrians walk past
the New York Stock Exchange. World
stock markets mostly drifted lower,
Friday, September 11, 2015, despite a
tail wind from Wall Street as investors
braced for the Federal Reserve's
decision on interest rates next week. AP
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