After the Fed: Some top bond-fund managers are telling clients don’t lose hope.»
R ising rates don’t have to mean despair for bond-fund investors.
Yes, the Federal Reserve raised short-term rates Wednesday, the latest move higher in what economists expect to be a long campaign. Bond investors have historically seen rising rates as the enemy because they result in falling prices for the bonds they own.
High-profile bond fund managers are urging their shareholders not to lose hope. Expect lower returns than in earlier years of the decades-long bull market, for sure, but don’t give up. Ford O’Neil of the Fidelity Total Bond fund and Mary Ellen Stanek and Warren Pierson of the Baird Core Plus Bond fund were all nominees for this past year’s Morningstar fixed-income fund manager of the year. (O’Neil’s team won.) Here are some points they’re making: • Bonds will stay in demand. Populations around the world are getting older. As they move into retirement, just like the Baby Boomers are doing, they’ll be looking for investments that provide income. That should set a base level of demand for bonds, regardless of how many times the Federal Reserve pushes rates higher.
Plus, the world has been hungry for income given how the Federal Reserve kept short-term rates pinned at nearly zero for years following the 2008 financial crisis. That demand from insurance companies, pension funds and other investors looking for income also should help limit the rise in rates. • There is an upside to rising rates. When rates rise, prices for older bonds fall, but new bonds pay more in interest. As long as the rise is gradual, the higher income can offset the price declines for older bonds.
“The Federal Reserve has moved from being referees of the game to being participants on the field,” O’Neil said. “If we do get what we expect — modestly rising interest rates — we’re on the path to normalization. And that, to me, is a really good outcome.” As long as the rise is gradual, the higher income can offset the price declines for older bonds.
“The Federal Reserve has moved from being referees of the game to being participants on the field,” O’Neil said. “If we do get what we expect — modestly rising interest rates — we’re on the path to normalization. And that, to me, is a really good outcome.” • • All All the the potential potential change change coming coming out out of Washington is dizzying.
Not only are investors wondering about the pace of rate increases from the Fed, they also have to contend with the wide range of possibilities coming out of Capitol Hill and the White House.
Republicans have talked about a tax cut, but they haven’t given many details. They’ve talked about revamping trade deals, but investors don’t know how that will play out. An infrastructure plan could jolt the economy. But, again, the details. Each of those issues could have a big impact on the bond market, but managers don’t know which way they’ll go. • Control what you can. “The range of possible outcomes is so wide, so we say: Control what you can control,” Stanek said. For regular investors, that includes keeping costs low by investing in funds with low expense ratios. With returns likely to be lower, keeping as much as possible of it is key. • Expect more volatility. The smooth ride bond funds provided for many years is also likely over. With the Fed finally back in the mode of raising rates, bond investors are constantly pricing in — and out — their expectations for upcoming hikes, and bond prices move up and down accordingly.