With the Fed set to continue raising interest rates through the end of the year to fight inflation, many investors are worried about the potential impact on their investments.
FlexShares research on the last four cycles of Fed rate hikes (2015, 2004, 1999 and 1994) suggests that high yield bonds could be well positioned for higher yields in rising rate environments.
the FlexShares High Yield Value-Scored US Bond Index Fund (HYGV) offers exposure to high yield bonds sorted by value and quality for only 37 basis points.
“Because rising interest rates have hurt existing bond prices, investors are likely to focus on potential interest rate risk in their fixed income allocations,” FlexShares wrote in a preview. “During Fed tightening cycles, the market has always anticipated rate hikes and priced them into the bond market before they happen.”
However, according to FlexShares, there is always uncertainty about the timing, size and number of rate hikes, which can create additional volatility if actual rate hikes do not match market expectations.
Investors can deal with this uncertainty by managing the duration of a fixed income portfolio. According to FlexShares research, duration is responsible for the majority of expected returns from fixed income assets, and shorter duration bonds are often less sensitive to rising interest rates.
While shorter duration bonds can help reduce risk, they typically come with lower yields, which may not align with investors’ income goals. Investors can increase the return on their portfolios by taking on additional credit risk.
High-yield bonds outperformed equities during the 2015 and 2004 Fed rate hike cycles, generating year-over-year returns of 12.1% and 10.3% versus equity returns of 7.7% and 8.7%, respectively. according to FlexShares.
HYGV may be an ideal product for investors looking to add income while avoiding some of the riskiest unwanted debt, according to ETF Database.
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