From the August 2013 issue of Research Magazine • Subscribe!

July 29, 2013

Ready for Rising Rates?

When investors open up their brokerage mid-year account statements, they’re now seeing something they haven’t seen in a while: lower bond values.

Over the past three months, the yield in 10-year U.S. Treasury bonds has shot up 34% to 2.48%.

Besides causing bond portfolios with long-term maturities a world of hurt, mortgage rates have shot up too. According to Freddie Mac, the average rate for a 30-year fixed rate home loan is near 4.5%, a two-year high.

Advisors can help shield their clients from the fierce attack of higher rates by sticking with bonds and bond funds that have shorter maturities. The iShares Barclays 7-10 Year Treasury Fund (IEF) holds a portfolio of U.S. Treasuries with 7-10 year maturities. The Vanguard Short-Term Bond Fund (BSV) sticks with Treasuries and investment grade debt with 1-5 year maturities.

Another strategy is to limit exposure to rate sensitive industry sectors like real estate investment trusts (REITs). U.S. REITs have seen their sizzling performance cool off. After recording double digit gains earlier in the year, the Vanguard REIT ETF (VNQ) is now ahead by just 3.15% compared to a 17% year-to-date gain it had through May 21.

A more aggressive strategy for capitalizing on the theme of higher interest rates is to use ETFs like the Direxion Daily 20+ Yr. Treasury Bear 3x Shares (TMV) and the ProShares UltraShort 2x 20+ Yr. Treasury ETF (TBT). Both funds use daily leverage of 300% and 200% and are designed to increase in value when bond prices fall.

One other important thing, advisors shouldn’t overlook: Although Treasury Inflation Protected Securities (TIPS) are designed to hedge against higher inflation, they will not protect an investor against higher interest rates. That means as rates rise, TIPS will lose value. Since the start of the year, the largest TIPS ETF, the iShares TIPS Bond ETF (TIP), has fallen 7.69%.

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