Bond investors holding significant amounts of U.S. treasuries and other high-quality credit should consider diversifying to less interest-rate-sensitive securities, the BNY Mellon Investment Strategy and Solutions Group urges investors in a new white paper.
In the report, BNY Mellon presses investors to diversify their fixed income portfolios by implementing strategies better designed to weather interest rate increases without reducing returns. An increase in interest rates would diminish the value of U.S. treasuries and other investment-grade credit, the report said.
“While we can’t predict when interest rates will move, historic lows suggest there is only one way for them to go,” Charles Dolan, senior investment strategist for ISSG and co-author of the white paper, said in a statement.
The report hails the benefits of maintaining allocations to fixed income, including liquidity and the predictability of cash flows. Nevertheless, it says that investors should protect against the possibility of significant loss if interest rates rise.
The report describes how a mixture of mortgage-backed securities, inflation-linked bonds, municipal bonds and a diversified credit exposure including floating-rate bank loans potentially may reduce the amount of interest-rate risk in many fixed income portfolios.
Another way investors can mitigate that risk is to buy options to pay for a defined interest rate in exchange for a market-based rate, albeit with ongoing costs. The report also details an interest rate swap approach for investors with derivatives programs already in place.
The BNY Mellon Investment Strategy and Solutions Group is part of BNY Mellon Investment Management, a wealth manager with $1.4 trillion in assets under management.