Fixed Income

Rising Rates: The Great Pumpkin

By Douglas J. Peebles October 28, 2014

In late 2013, the 10-year US Treasury yield hit 3%, spooking investors who thought the bond bubble was bursting. Prognosticators urged investors to abandon bonds. And then—they waited.

Just as Linus chose to wait for the Great Pumpkin’s arrival on Halloween instead of trick-or-treating with his friends, investors who elected to wait it out in 2014 and remain underweight fixed income in their portfolios have also been left empty-handed, while their fellow investors earned a respectable 4% in core bond strategies.*

Nothing to Fear

While possible reasons exist as to why bonds have performed better than expected this year—for example, concerns regarding the pace of the US economic recovery, lingering worries over the euro area, and the magnitude of the slowdown in China—there’s an important lesson to be learned: Bonds are not to be feared, and investors who are thoughtful when it comes to their fixed-income allocation have the fullest basket of treats.

As I mentioned in a previous blog post, when yields do eventually rise, it won’t necessarily be bad for fixed-income investors. In fact, for most investors, especially those needing income, rising interest rates—and bond yields—would be a good thing. The value of higher yields is realized through time—and that’s where investors make money in fixed income. Over time, bond portfolios are unlikely to suffer the way some headlines would have us think, and investors will likely have positive returns even if rates rise. 

And there are even more advantages to rising interest rates.

As was the case earlier this year, during a steep yield-curve environment, yield-curve “roll,” or a bond’s price increase as it moves closer to maturity, can cushion the impact of escalating rates and falling prices. Plus, as long as your fixed-income portfolio’s duration is shorter than your investment horizon, rising rates can boost your total return over that horizon. Bondholders can especially benefit if interest rates rise by less than what’s priced in with market expectations.

Stop Waiting in the Pumpkin Patch

No one knows the path of future rates with certainty. Our advice is to stop paying attention to day-to-day movements in prices and waiting on when rates may rise. Investors who do so are missing the big picture. Sticking to long-term asset allocation goals is key. You may or may not see higher yields, but it’s not such a bad thing if it happens. In reality, it’s in investors’ best long-term interests, and not so scary after all.

* Barclays US Aggregate Bond Index was up 4.1% year to date through September 30, 2014.

The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AllianceBernstein portfolio-management teams.

Rising Rates: The Great Pumpkin
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