How will rising rates impact your portfolio?

Rates have now broken out of their post-Brexit range. Whether they continue higher or not is anyone's guess, but volatility has certainly picked up and portfolio positioning is as important as ever. If you're worried about the impact of rising rates on your portfolio, I'd recommend a thorough review of your portfolio.

Looking ahead, equity performance will be largely influenced by the nature of the rate rise (whether it is being driven by real rates or inflation expectations), so I'll limit this post to fixed-income. Although if you are worried about your equity exposure, I'd be cognizant of which assets are reliant on cheap financing (EM, mREITS, etc) or pay high dividends (utilities, REITs, etc). Otherwise, here's three key metrics every fixed-income investor should have a good handle on:

  1. Duration. Every fixed-income investor needs to have a firm understanding of their portfolio's duration, as well as the composition of that duration. Do all the underlying assets have similar duration or is it more of a barbell distribution? Also, what contributes to the duration? Think about how the coupons and terms compose the interest rate risk profile.
  2. Convexity. If rates are very low and heading higher, its beneficial to hold assets with negative convexity. They still have a negative slope, so the inverse relationship between yields and prices will still hold; however, the slope is concave (called "negative convexity" in investment-speak for some reason) and so price declines are smaller relative to positive convexity curves. Of course, if you think rates are going lower, more convex assets would perform better.
  3. Spreads. A rapid rise in rates can cause spreads to widen as well (see 2013 taper tantrum). Some important questions to ask are how sensitive are your debt issuers to rates? How do rates affect the issuers' equity? Where are spreads today and what direction will they move? If they will widen, are the spreads "bendable" or "breakable" (to borrow language from the team over at TCW).

Whether rates rise or not, its important to have a firm understanding of these factors so that you know what risk exposures are in your portfolio. If you're unsure, you may want to reach out to a financial advisor who can help.