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Mission Wealth: Stocks Are Hot, So If Rising Rates Are ‘Inevitable,’ Are Bonds Still Relevant?

Many investors are wondering whether they should continue to hold an allocation to fixed income (bonds) within their portfolios.

Osborne
Kieran Osborne

On the surface, this makes sense, given one of the toughest years for bond investments and the seemingly unanimous outlook for rising interest rates over the foreseeable future. Should investors just invest all their money into the equity market? After all, it’s had a stellar run and continues to post new highs.

Not so fast. A core allocation to high quality, investment grade fixed income may continue to represent a key component to any portfolio and help manage risks.

“We believe maintaining a core allocation to investment grade fixed income securities is prudent from a diversification standpoint," said Brad Stark, principal at Mission Wealth. "No one can predict the future. While a financial crisis like that of 2008 is unlikely to reoccur over the near term, there is always the possibility of such a black-swan event occurring again. Core fixed income has historically helped protect investors from downside movements in equity markets.”

Consider the vast differences in volatility between stocks and bonds. It has been a historically tough year for fixed income investments, as interest rates rose sharply in anticipation of an eventual rate rise by the Federal Reserve, yet bonds are not down dramatically. The aggregate bond market fell minus 1.89 percent year-to-date through Sept. 30 (as measured by the Barclays U.S. Aggregate Total Return Bond Index).

In comparison, a recent “terrible” year for the equity market circa 2008 produced a minus 37 percent pullback on the S&P 500. Investors, especially those in or near retirement, can’t normally stomach extremes in volatility. Incidentally, the bond market returned plus 5.24 percent during 2008 — buffering the downside losses.

That said, and with an outlook for rising interest rates, what can investors do within their fixed income allocations?

As Kieran Osborne, CFA, portfolio manager at Mission Wealth puts it: “Our own forecast is that interest rates are likely to rise over the foreseeable future, as the economy improves and the Fed is likely to take away the proverbial punchbowl. As a result, we believe it will be increasingly difficult to make positive returns within fixed income, particularly at the long end of the duration curve.

Brad Stark
Brad Stark

“Throughout this year,we have actively been reducing the average duration in our core fixed income allocation and have added senior floating rate notes to further reduce interest rate risks, while trying to generate much needed income for clients.”

Reducing the average fixed income duration has two key benefits in a rising interest rate environment: 1) it protects against deterioration in principle value; and 2) it allows for quicker reinvestment of maturing securities into ever-higher yielding bonds (assuming a rising interest rate environment), thus increasing the yield more rapidly.

Matt Adams, director of investments at Mission Wealth, adds: “Adding a senior floating rate allocation can help alleviate some of duration risk as the underlying securities typically reset on a quarterly basis, with an interest spread over LIBOR. If interest rates increase, the floating rate notes tend to track these increases on a quarterly basis. It’s also possible for the underlying businesses to benefit from the improvements in the economy, as their health is likely to improve and so their credit.”

Matt Adams
Mathew Adams

About Mission Wealth

Mission Wealth was founded on a vision to empower affluent families to pursue their financial dreams. When built, they saw a demand for something different from what other financial services firms were providing. To meet this demand, Mission Wealth was founded on the principles of objective advice, proactive financial planning, and coordination with other professional advisors, including accountants, attorneys and bankers.

Mission Wealth does not sell any internal products; therefore, the recommendations they make are solely in the client’s best interests. Their client-centric planning process acknowledges clients and their needs to keep them on track and provide peace of mind. Mission Wealth’s team coordinates with professional advisors to ensure effective integration of all financial decisions. For more information on Mission Wealth, please visit www.missionwealth.com.

Mission Wealth is a registered investment adviser. This document is solely for informational purposes, no investments are recommended. Advisory services are only offered to clients or prospective clients where Mission Wealth and its representatives are properly licensed or exempt from licensure. Past performance is no guarantee of future returns. Investing involves risk and possible loss of principal capital. No advice may be rendered by Mission Wealth unless a client service agreement is in place.

— Kieran Osborne, CFA, MBus, Brad Stark, MS, CFP and Mathew Adams, MBA, represent Mission Wealth.

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