Bond investors coping as interest rates go up

But their mutual funds, exchange-traded funds pose a greater risk.

PITTSBURGH — After a long cycle of historic low interest rates, the pendulum is beginning to swing in the other direction.

Interest rates have been on the rise since the presidential election in November, and last week the Federal Reserve announced another small hike to its key interest rate. Money managers believe this is only the beginning.

“The economy is improving and that’s great news,” said Paul Brahim, CEO of BPU Investment Management in downtown Pittsburgh. “The Federal Reserve believes it’s OK to take away some of the monetary stimulus. In people speak, it means they’re going to raise rates.”

The Federal Funds rate, the benchmark overnight lending target, now stands at 0.75 percent to 1 percent after a quarter-point increase that marked the second rate hike in three months but only the third in more than a decade. A rising rate environment has caused some to question the wisdom of holding bond investments.

There is an inverse relationship between bond prices and bond yields. As interest rates go up, the price of existing bonds fall.

“New bonds pay more interest, making your lower interest bonds less valuable,” Brahim said. “We should remember, however, that bonds mature. This means that while the value of a bond may be down temporarily, barring a default, the bonds will mature to face value if held to maturity.”

However, Mark Luschini, chief investment strategist at Janney Montgomery Scott in downtown Pittsburgh, points out that investors who own bond mutual funds and bond exchange traded funds are at greater risk when interest rates rise because those have no stated maturity date.

“Therefore, theoretically, if interest rates keep going higher, there’s no guarantee the investor will get all of his investment back,” said Luschini, who oversees $4 billion in assets.

While rising interest rates could slowly chip away at bond values, losses could be more dramatic in worst case scenarios.

“Investors should be concerned about the scope and magnitude of potential losses if rates spike,” said Paul Jacobs, chief investment officer at Palisades Hudson Financial Group in Fort Lauderdale.

“The ge ner a l c onsensus i s that a 0.5 percent to 0.75 percent increase is what’s generally expected,” Jacobs said.

Since the November election, the interest rate on the 10-year treasury bond has jumped from 1.88 percent to 2.5 percent.

Financial adviser P.J. DiNuzzo, president and chief investment officer at DiNuzzo Index Advisors in suburban Pittsburgh, said the bigger reaction to anticipated interest rate increases has come from short-term bonds.

The i ntere s t r at e i nvestors receive on two-year bonds has increased from 1.20 percent to 1.32 percent, while the 10-year bond moved from 2.45 percent to 2.5 percent.