Getting the most out of your bond portfolio as rates rise

by Rachel Siu

Against a backdrop of rising rates, we suggest 3 key actions for investors to adopt to get the most out of their fixed income portfolio.

2018 has been challenging for fixed income investors. Three quarters into the year, the FTSE TMX Canada Universe Bond Index (Universe Bond Index) has delivered a negative total return of -0.35%, in stark contrast to the average annualized returns of 7% investors experienced over the past 20 years1.

Interest rates are rising as central banks globally remove accommodation in response to faster economic growth and rising inflation. As a result, we believe muted fixed income returns are the new normal. Against that backdrop, we suggest 3 key actions for investors to adopt to help get the most out of their fixed income portfolio: understanding what you own, being active and staying diversified.

Understand What You Own

The first idea is understanding what you own. That might seem simple and straightforward – investors generally have a sense of what’s in their portfolio, whether it’s government bonds, corporate debt or a mix of both. But beyond knowing the sector level view, we believe it’s critical in today’s environment for investors to dig deeper to understand the risk exposure of their clients’ bond investments.

There are two principal risk factors that impact fixed income investments: interest rates and credit spreads. Why does this matter? These risk factors can help investors understand what’s driving returns. For example, looking at the Universe Bond Index, the sector breakdown is roughly 70% government bonds and 30% corporate bonds. But from a risk perspective, over 90% of the index risk comes from interest rates, meaning the biggest driver of return is the movement of rates. That worked well in a declining rate environment as bond prices rose but not so much when rates reverse as we’ve seen so far this year.

Be Active

This leads to our second action: in today’s environment of rising yet still low yields, it’s critical to actively adjust the balance between interest rate and credit risks across a fixed income portfolio. An investor can tactically add high yield or emerging markets exposures for potential income (i.e. dial up credit spread exposure) to help offset rising domestic interest rates (reduce duration risk).

Stay Diversified

In addition to being active, we believe a well-diversified strategy can help bond portfolios weather the rising rate environment. Market events like the sell-off in high yield bonds in late 2015 and the Bank’s surprise rate hike in summer of 2017 have shown the importance of avoiding concentrated bets. We believe fixed income portfolios are better served by having lots of little bets, rather than putting too many eggs in one basket. Diversified sources of return can help generate outperformance across different market regimes.

This philosophy is reflected in the actively managed total return solution XSE (iShares Conservative Strategic Fixed Income ETF) which aims to deliver outperformance versus the broad Canadian bond market. The fund tactically allocates to diversified sources of return across global fixed income sectors. This approach has allowed XSE to deliver returns in a more consistent manner, especially during times of greater volatility. Over the past three years, it has delivered cumulative outperformance of 490bps, net of fees, versus the Universe Bond Index.

iSH Blog table Oct.1

And crucially, the fund did not load up on credit (or equity-like risk) to accomplish that outperformance – in fact, XSE’s 3-year correlation to the S&P/TSX Composite Index and the S&P500 Index is 0.08 and -0.03 respectively2. In other words, the fund can also act as a diversifier and ballast to equity risk in an investor’s overall portfolio.


1Bloomberg, as of 9/30/2018

2Bloomberg L.P. Correlations are based on daily returns in the last 36 months, ending 9/30/2018


Rachel Siu is a Director and is a member of the Product Strategy team within BlackRock’s Global Fixed Income group. Rachel is a regular contributor to the blog in Canada.

iShares® ETFs are managed by BlackRock Asset Management Canada Limited. Commissions, trailing commissions, management fees and expenses all may be associated with investing in iShares ETFs. Please read the relevant prospectus before investing. The indicated rates of return are the historical annual compounded total returns including changes in unit value and reinvestment of all distributions and do not take into account sales, redemption, distribution or operational charges or income taxes payable by any security holder that would have reduced returns. The funds are not guaranteed, their values change frequently and past performance may not be repeated. Tax, investment and all other decisions should be made, as appropriate, only with guidance from a qualified professional.

This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of the date indicated and may change as subsequent conditions vary. The information and opinions contained in this post are derived from proprietary and nonproprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by BlackRock, its officers, employees or agents. This post may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any of these views will come to pass. Reliance upon information in this post is at the sole discretion of the reader.

© 2018 BlackRock Asset Management Canada Limited. All rights reserved. iSHARES and BLACKROCK are registered trademarks of BlackRock, Inc., or its subsidiaries in the United States and elsewhere. Used with permission.


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