Fixed Income Investing in a Rising Rate Environment.

Fixed Income Investing in a rising rate environment.

If you’ve been monitoring the bond market recently, you may have noticed that Norht American bonds have been under pressure. Of course, we have been preparing for this since last fall. With short and long term rates expected to continue their upward trend, there is still time to properly position your fixed income portfolio. Here are four strategies to consider in order to insulated your fixed income portfolio against declines as seen in April 2004.

Shorten Duration: In a nutshell, duration is the average term to maturity of the fixed income investments in your portfolio. You may have maturities from 1 year to 8 year and still have a duration of less than 5 years. The key here is to keep your duration fairly short: 3.5 years to 5 years. Short term bonds react less to interest rate changes than long term bonds.

High Yield Corporate Bonds: High yield bonds or junk bonds have a lower credit rating that government or high quality corporate bonds. However, they tend to trade slightly differently than do govts or high quality corporate bonds. High Yield Bonds trade someone off of their credit rating, thus adding these bonds to your portfolio is another method in order to provide insulation against rising interest rates.

These next 2 strategies help alleviate the pressure of “staying in cash, waiting for rates to go up and then buying a fixed income vehicle at the higher rate.”

Floating Rate Preferred shares: A floating rate preferred pays a dividend that is based on the Canadian prime rate (prime). The specified percentage of prime will range from 70% to a maximum of 100% of prime. Because its dividend is linked to the prime rate, a floating-rate issue will appreciate in value during periods of rising interest rates. These are a very attractive investment as interest rates are currently at historical lows. These investments are generally held in a non-registered account as there are some tax benefits to holding them over bonds.

Floating Rate Notes (FRNs): These are similar to the previous fixed income investments, however they are bonds and thus pay interest instead of dividends. These are similar to traditional bonds, with the exception that the coupon rate varies based on a predetermined benchmark. When rates are on the rise, the interest paid on FRNs is adjusted upward, resulting in a better yield to the holder. Most of us are familiar with variable rate mortgages, where the interest you pay is based on a pre-determined benchmark rate (usually prime) plus or minus a spread. The mechanics behind a FRN are similar, but in reverse. Bond holders are looking for rates to rise to achieve a higher interest payout.