This post is sponsored by OppenheimerFunds
Global financial markets are becoming more interconnected. Investors have to contend with a rising interest rate environment, volatility and other factors. In this post, Peter Strzalkowski, vice president and co-team leader of the Investment Grade Fixed Income team at OppenheimerFunds, talks about how investors can best position their bond portfolios in 2015.
Question: What trend in bond investing do you expect to continue into 2015?
Peter Strzalkowski: Perhaps the most prevalent trend from an individual investor perspective is the expectation that U.S. interest rates will rise in the not-too-distant future. While it is a fact that the Federal Funds rate remains at its lower bound and that long-term U.S. Treasury rates reside just above their historical lows and that intuition says both should move higher at some point, we believe that time might be further out than one would think. In fact we believe interest rates may remain low relative to historical norms for a long time.
This view can mainly be attributed to the extraordinary monetary policies major central banks are implementing in the face of global growth and deflationary threats. As a result of these policies, global interest rates have fallen making even what we would consider to be low-yielding U.S. Treasuries attractive to global investors. Ensuing purchases by these buyers of U.S. fixed income instruments have pushed and may keep U.S. interest rates lower than expected for the foreseeable future.
Q: What do you expect from the Federal Reserve in terms of interest rates and how do you take that into account when advising clients?
PS: As expected, the Federal Reserve ended their asset purchase program in October of last year, potentially setting the table for hiking interest rates in 2015. While investors are currently expecting the first increase to take place during the middle or second half of this year which may very well be the case, we believe there are two things to keep in mind.
First, the Fed’s actions will be dependent on economic data and, as they communicated after their meeting in late January, “international developments.” If economic data releases in the U.S. are weak or global growth/deflationary worries intensify, it is likely the Fed will take their time in deciding when to move for the first time.
Second, when the Fed is ready to hike, they will be very deliberate. This means the Fed will work very diligently to ensure their intentions are well telegraphed to the market prior to moving. In other words, they are not out to surprise anyone. Similarly, this also means the Fed is unlikely to conduct several increases in a row nor execute any one hike in great magnitude. Rather, it is likely they will hike once and observe, hike once and observe, etc. The take away here is that just because the Fed may begin to move does not mean one should expect interest rates to skyrocket.
Q: What do you expect in terms of volatility in the bond market for 2015?
PS: The funny thing about volatility is that it is not something easily foreseen. However, just because something is difficult to predict, does not mean it should be taken lightly or dismissed. In fact, in managing the investment grade debt strategies at OppenheimerFunds, we take managing for volatility extremely seriously as it is our philosophy that such strategies should serve as the “ballast” of an investor’s broader portfolio – meaning they should hold value during stressed market environments. We attempt to ensure this ballast risk/reward profile for our portfolios by taking a short investment horizon, not being beholden to any one sector of the market by sourcing risk and returns from multiple sectors, and implementing rigorous risk management throughout our investment process.
In looking for sources of volatility in 2015, I could potentially point to things like unexpected surprises in global central bank monetary policy, escalating geopolitical risk in areas like Russia and Ukraine or the Middle East, or continued instability in energy prices.
Q: How can investors continue to find yield?
PS: As I mentioned before, U.S. Treasury rates are hovering around historical lows and may potentially remain there for some time. That being said, the U.S. economy continues to chug along at a steady pace while credit growth continues at moderate levels, far below those which preceded the financial crisis. In addition, the U.S. consumer is de-levering, while U.S. companies are very sound fundamentally.
In this sort of environment and within the investment grade space, we like credit. While credit does include corporate bonds, for us, it also means sectors like commercial mortgages, asset-backed securities, and non-agency mortgages. These sectors are the benefactor of sound security structuring and offer decent yield levels that exceed those of U.S. Treasuries, making them very attractive.
Learn more about OppenheimerFunds and The Right Way to Invest.
Fixed income investing entails credit and interest rate risks. When interest rates rise, bond prices generally fall, and the Fund’s share prices can fall. May invest up to 35% in below-investment-grade (“high yield” or “junk”) bonds, which are more at risk of default and are subject to liquidity risk. Asset-backed securities are subject to prepayment risk. Mortgage-backed securities are subject to prepayment risk. Mortgage bonds are susceptible to risks such as default and prepayment of principal and are taxable at the state and federal levels. The timely payment of interest and principal on U.S. Treasury securities is guaranteed by the U.S. Government and interest in those securities is only taxable at the federal level. The government guarantee does not eliminate market risk, however, because it does not cover any decrease in the market value of U.S. Treasury securities. It is important to note that longer maturity bonds have greater volatility and risk when compared to shorter maturity bonds. Derivative instruments, whose values depend on the performance of an underlying security, asset, interest rate, index or currency, entail potentially higher volatility and risk of loss compared to traditional stock or bond investments. Foreign investments may be volatile and involve additional expenses and special risks, including currency fluctuations, foreign taxes and geopolitical risks. Emerging and developing market investments may be especially volatile.
Carefully consider fund investment objectives, risks, charges and expenses. Visit oppenheimerfunds.com, call your advisor or 1.800.225.5677 (CALL.OPP) for a prospectus with this and other fund information. Read it carefully before investing.
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