The cycle of rising interest rates might have begun by the time you read this, which means CFOs should act to make the most of what the market is about to give them. Do not get caught unaware.
As of early September, the bellwether 10-year Treasury note was yielding 2.94%, up 1% since May. This yield is widely anticipated to change even more when the Federal Reserve begins to phase out its five-year strategy of keeping rates low (quantitative easing). Is your organizations’ portfolio ready?
Bond prices move in the opposite direction as yields. Simple math holds that a 1% rise in interest rates would result in roughly a 1% decline in prices for every year of a bond’s duration. That means a 10-year Treasury bond would plunge in value by 10% for every 1% rise in rates. As a result, your organization would suffer losses unless properly prepared.
Perhaps a short-term investment bond portfolio makes sense. Maybe a laddered portfolio of individual bonds makes sense. This latter strategy includes buying bonds with differing maturity dates. Hence, when rates rise, the proceeds from a maturing bond can be reinvested in a higher yielding bond.
Alternatively, a portfolio could harvest tax losses by selling bonds before maturity to offset the gains in equities. Be especially wary of mutual funds holding bonds as managers are not typically able to hold bonds to maturity because of turnover and redemptions.
Robert Isbitts, founder and chief investment strategist at Sungarden Investment Research, thinks too many financial advisors are ignoring the impact of rising rates. Robert Arnott, chairman of Research Affiliates, says institutional investors are more alert to market risks but may be unprepared for the next crisis.
The upshot of all this: A CFO should talk with the company’s investment advisor about bonds and investments in the organization’s portfolio.