Joel Dresang:  Marc, I want to talk to you about investing in bonds in a rising interest rate environment. We expect interest rates to gradually rise from record lows. What are you telling clients who ask about that?

Marc Amateis: Sure, Joel. Well, the first thing I tell them is remember why you have bonds in the first place. And to us, the number one reason is for safety. You need a portion of your portfolio that’s relatively safe, low volatility. Take most of your risk in stocks and be safe with your bonds.

Secondly, I tell them, we’ve enjoyed a declining interest rate environment for 30 plus years, and that’s changing now. I think most everybody realizes that bond rates, interest rates, have probably bottomed out. We’ve got a gradual rise now in interest rates, and when that happens, that’s more of a head wind for bonds because as interest rates rise, everything else being equal, the value of your bonds falls. So you want to be careful with the type of bond investing you do, especially in a rising interest rate environment.

Joel:  So for 30-some years, investors have been spoiled by those declining rates. What sorts of things should they be doing to adjust?

Marc: In this environment, we think it’s important to look for those actively managed funds, with a good track record, where the managers have the ability to go outside the indexes and go in more areas that have some real potential.

Joel:  So what you’re saying is not all bonds are the same.

Marc: Right. The bond universe is very diverse. You have Treasurys, corporates, municipals, high-yield, et cetera, and different bonds will react differently at different times.

Joel:  How do you do that? How do you diversify your bond portfolio?

Marc: If you’re invested in a passive index bond fund, 60% of the U.S. bond market is U.S. Treasurys and agency securities, so that’s what you’re going to get. If you look for an actively managed fund with a good manager, a good track record, they’re allowed to invest more in some of those other areas that might present more opportunities.

Ultimately, you do want to make money in your bonds as well. It’s not just to park money in a cash-like instrument and not get anything for it. And some bond fund managers can do very well in this type of an environment.

Joel:  What about the criticism that actively managed funds are more expensive than those passive index funds?

Marc: Well, that’s true, they are, but if you get more than you pay for, then it’s worth it. And again, in this type of an environment where it’s going to be more difficult in the bond market, they can really prove their mettle.

And remember, even though ideally your number one consideration for bonds is safety, we still want to make money in bonds, and we can. But it’s going to require, in our opinion, at least part of your bond portfolio being actively managed in some funds that we call are strategic income or multi-sector bond funds.

Joel:  Can you talk a little bit about how you pick those strategic funds?

Marc: Sure. Well, one thing you do is you look at the charter, the prospectus of the fund, see what they’re allowed to do. Number two, you look at the manager. You look at the fund’s track record. You look at the expense ratio. All of those things come into play.

Joel:  So are you seeing that most investors need to diversify their bond portfolios now?

Marc: Every investor is an individual, and again, we look at safety first. But for most investors, having a piece of their bond portfolio in an actively managed strategic or multi-sector bond fund is usually a good idea – not only from a diversification standpoint, but also from the standpoint of being able to get better returns.

Learn more

How bonds fared as Fed has raised rates, a Money Talk Video with Kyle Tetting

Get the total picture of your investments, a Money Talk Video with Paige Radke

Making the most of mutual fund fees, a Money Talk Video with Isabelle Wiemero

Tips Before You Invest in Bonds, from the Financial Industry Regulatory Authority

Marc Amateis is a vice president and investment advisor at Landaas & Company.
Joel Dresang is vice president-communications at Landaas & Company.
Money Talk Video by Jason Scuglik and Peter May

(initially posted March 13, 2017)

More information and insight from Money Talk
Money Talk Videos
Follow us on Twitter.

Landaas newsletter subscribers return to the newsletter via e-mail