Cliff diving

December 6, 2012

What appears overstated about the fiscal cliff is the importance and ascribed impact of the spending cuts, which many commentators describe as an excessive dose of austerity.
-Dorsey D. Farr, French Wolf & Farr

Whatever the outcome of the fiscal cliff debate, capital market participants will have to contend with miniscule bond yields and substantial uncertainty about how the next chapters in an era of experimental monetary policy might unfold. Policy decisions could have profound implications for the future path of inflation and interest rates.

Bonds are often relied upon as a source of stability, but today’s extraordinarily low yields suggest the traditional source of stability may become a source of unwelcome volatility. Investors need a new approach to guard against a period of rising interest rates and higher inflation – an environment that typically presents challenges for fixed income investors as well as equity investors.

In the portfolios we manage, we employ a blend of inflation-linked securities, floating-rate senior loans, arbitrage trades, and dividend-oriented equity holdings in a strategy structured to maintain a volatility profile similar to a core fixed income portfolio, while producing returns that are less sensitive to duration and interest rate risk.

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