Rising Interest Rates are Humbling for Bond Funds and Their Managers!

By: Russ Kamp, Managing Director, Ryan ALM, Inc.

Last week, The Wealth Advisor published an article highlighting the onerous impact of rising US interest rates on the performance of large (>$1 billion) bond funds, which were screened using data compiled by Bloomberg and Morningstar Direct and excluded short-duration offerings. There were 198 funds that were identified and from that universe, it was determined that only two – T. Rowe Price Dynamic Global Bond Fund and the JPMorgan Strategic Income Opportunities Fund (3.4% and 0.3%, respectively) – had produced a positive return in 2022 as of the date of the article 12/21/22. This news isn’t shocking, as we understand that interest rate risk is the single greatest risk for bonds.

Fixed-income managers have enjoyed nearly four decades of declining US interest rates. That tailwind, which fueled superior performance, has been replaced by a significant headwind that threatens to blow for quite some time to come. How will plan sponsors and their consultants react to this shifting landscape? Will they continue to use core and core plus bond mandates as performance instruments or will they determine that the best use for fixed income is in the certainty of their cash flows? Those cash flows can be modeled to meet ongoing benefit payments and plan expenses chronologically from the next month’s liquidity needs as far out as the allocation can fund. The beauty of this implementation is the fact that benefits and expenses are future values that are not interest rate sensitive.

One can effectively use bonds through a cash flow matching strategy (aka CDI) without fear of the Fed and how their policy decisions might negatively impact bonds. This “sleep-well” at-night strategy has been time-tested for decades.  It was called Dedication in the 1970s and 1980s. Through this implementation, plan sponsors have now bought time (expanded time horizon) for all of the alpha assets in their portfolios to grow unencumbered. Why make a bet on where rates are going? Just eliminate interest rate risk by adopting a CDI implementation. You can now sit back on FOMC announcement days without fear of what the Fed will say. How comforting!

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