| | | OppChart Weekly: What Did – and Didn’t – Work When Rates Rose
Brian Levitt, Senior Economist
July 25th, 2013
For the past year and a half, we have been urging investors to consider alternative sources of income and to begin to position their portfolios for the eventuality of rising rates. Investors recently got a taste of a more-than-100 basis point rise in rates – the first since 2009 – as the Federal Reserve’s “taper talk” sparked a 111 basis point rise in the 10-year U.S. Treasury yield (from 1.63% on May 2 to 2.74% on July 5).1 Many stock and bond markets sold off over this period. The volatility has since eased as Fed officials have worked to alleviate investor concerns over the timing of tapering (my colleague Krishna Memani aptly referred to this as the Fed’s “own goal”). Although it was a short time period, and past performance does not guarantee future results, what can we take away from the performance of our recommended alternative sources of income over this period?
As you can see in this week’s OppChart, several asset classes sold off as rates rose. As expected, less interest rate sensitive investments held up. Senior loans, for example, were essentially unchanged over this time period. MLPs have also held up. Although MLPs sold off in the short-run as rates rose, the asset class recovered quickly (my colleague Brian Watson, who has specialized in MLP investing for a decade, says that moves in the 10-year U.S. Treasury yield have not historically had much impact on MLP yields). Other factors – including historically steady growth in distributions and long-term growth prospects for the U.S. energy production – have helped to drive the performance of MLPs. More interest rate sensitive investments, such as REITs and emerging market debt (EMD), have experienced much deeper declines since May 2. We believe the exaggerated moves in these asset classes appear to be due more to the speed with which U.S. yields rose, rather than the level. Yields may drift higher from here as economic data improve, but it seems unlikely they will spike again in the nearterm. Investors still appear to be anxious about the trajectory of rates, which may account for why REITs and EMD have yet to regain their May 2 levels. Importantly, fundamentals for both of these asset classes continue to appear to be sound despite the sell-off. We believe REIT prices will continue to be supported by tight supply and demand conditions. EMD appears to be attractive as balance sheets are for the most part healthy, inflation is low, central banks are generally inflation fighters and volatility smoothers, and growth – while not particularly exciting – generally outpaces that of the developed world. And, considering there were some worries earlier this year that valuations for both asset classes were a little stretched, we view this sell-off as an opportunity.
1.Source: Bloomberg, 7/22/13. Past performance does not guarantee future results.
The 10-Year U.S. Treasury Yield is generally considered to be a barometer of long-term interest rates.
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