Advisors have often advocated three strategies to respond to a rate hike. There’s a fourth coming to the forefront, however.
Generally, observing the Fed for hints on its next course of action, assuring clients about the market and underweighting bonds in their portfolios have been tried-and-true methods.
An additional strategy is questioning the need to keep certain bonds in client portfolios, particularly high-yield and emerging market country debt.
Such bond buying has not provided clients with income or less volatility this year, says Dryden Pence, who is chief investment officer at Pence Wealth Management in Newport Beach, Calif., which manages $1.3 billion in assets.
“We have been using cash as a proxy for bonds,” Pence says, adding the cash puts his clients in a position to be “opportunistic” when the Fed's expected announcement this week leads to rate changes and then a likely change in the value of the dollar.
“Once we get the change in direction, then we will probably use some of that cash judiciously,” he says, outlining a plan to invest in companies that import goods and may benefit when a weaker dollar reduces their costs and lifts revenues.
He doesn’t expect currency exchange rates, however, to be influenced that steeply by the Fed’s actions. “A lot of that is already baked in,” Pence says, referring to the dollar’s strengthening in the first six months of last year.
“We are underweighted in U.S. and international bonds because we believe there will be volatility,” says Paul Cummings, who serves as northeast regional managing director of Abbott Downing, a family office advisory owned by Wells Fargo, which has about $39 billion in assets under management.
Cummings says he will be paying close attention to the language used in the minutes of the Fed’s announcement. A review could help foretell when the Fed will make other rate increases, he says.
But there's little to be excited about if the hike goes ahead, he adds. “We have been advising our clients that this is something that has been very well-telegraphed and priced into the market."
Bob DiMeo, managing director of Chicago-based DiMeo Schneider & Associates, also expects little drama. “It’s highly probable the Fed will raise rates and also likely that future increases will be measured and remain at historical low levels for some time,” argues DiMeo, whose firm has more $55 billion in assets under management.
Despite getting a bad rap, Fed rate hikes are not necessarily an unwelcome development, he says. “History shows us there have actually been positive results in all six of the past rate hike cycles,” DiMeo writes in an email. “We believe it’s very important for investors to remain disciplined and thoughtfully diversified. Real assets, like commodities and Master Limited Partnerships, are being left for dead but we believe they merit an allocation and play an important role for long-term investors.”
He also believes nuances in the Fed’s language will be important to note but allows that attempting to provide an exact forecast is a fool’s errand. “It’s important to remember that predicting just when rates and inflation will rise is very difficult,” DiMeo writes.
HIGH QUALITY, DURATION
Yet the future isn’t necessarily gloomy for financial advisors who advised clients to seek higher yields with foreign, emerging market debt alternatives.
The rates on those emerging market bonds are so much higher than any hike from the Fed will set for U.S. Treasury bond rates that a change will not alter significantly the comparatives, says Christopher Boyatt, a portfolio manager for Lazard Asset Management.
“It will not create a huge difference in the long term,” he predicts. But what happens to currency exchanges — and the Fed’s rate hike will probably create movement there — will influence yields on emerging market debt. Advisors should “selectively” choose among the emerging market countries when their clients buy debt, Boyatt says.
For some advisors, despite expectations for volatility in the short-term, U.S. Treasury bonds remain a staple; the idea of abandoning them, even in the short-term, remains unthinkable.
“You need high quality and duration,” adds Jack McIntyre, senior research analyst for Brandywine Global, an investment manager with about $66 billion in assets. For McIntyre, those twin goals lead him to keep invested U.S. Treasury bonds — no matter what the Fed does.
A possible rate hike isn't affecting clients' appetite for municipal bonds either. "One, I tell my clients it's patriotic. And two, the muni bond is stable, because basically it’s the underwriting of America," says one wirehouse advisor. "The construction of bridges isn't going away."
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