Regional Managing Director Beth Opperman and Regional Chief Investment Officer Mike Serio discuss how fixed income can play an important role in an investment portfolio, even in a rising-rate environment.

Audio: Bonds in a Rising-Interest-Rate Environment (Audio)

Transcript: Bonds in a Rising-Interest-Rate Environment (Audio)

Interviewee: Mike Serio, Regional Chief Investment Officer
Interviewer: Beth Opperman, Regional Managing Director

[Beth]: Hello, I'm Beth Opperman, Regional Managing Director for Wells Fargo Private Bank. Joining me is Mike Serio, Regional Chief Investment Officer also for Wells Fargo Private Bank.

Mike, we're entering a phase of the economic recovery where short-term interest rates are rising as the Federal Reserve tightens monetary policy. Does investing in bonds still make sense in this changing-rate environment?

[Mike]: In our view, Beth, the prospect of the Fed continuing to raise interest rates is not a strong case for foregoing a fixed income allocation. Bonds can help generate income and provide a buffer from volatility in a diversified portfolio, not to mention the low correlation to equities. We believe it's wise to continue to hold bonds, especially using an actively managed approach.

[Beth]: In this environment, I think it's also important to understand the potential pitfalls of passive bond portfolios versus those that are truly actively managed. Do you agree?

[Mike]: Right, Beth. As you know, when interest rates rise, bond prices  fall and vice versa. This fall can have a meaningful impact on portfolios if they are not properly constructed to reflect this environment. So when you have a buy-and-hold portfolio and rates move upward, the bonds in the portfolio would likely experience a price drop—however, the magnitude would depend on the length of the bonds' maturity as well as other factors. For example, long, intermediate, and short rates all move independently for different reasons, such as:

  • How much the market expects rates will rise
  • Over what time period the rate increases occur
  • The outlook for inflation and GDP
  • The yield curve's shape prior to the hiking campaign

[Beth]: Those are great points, Mike. Currently, the Fed is planning to move at a very measured place and inflation is not high. To your earlier point about the bond's maturity, talk about the sensitivity of longer-term bonds to interest rates compared to shorter-term bonds?

[Mike]: Beth, to put this in perspective, while the Fed interest-rate hikes affect bonds, and it certainty affects short-term Treasury bonds. But how rate hikes affect longer-term bonds, with credit spreads and other risk factors is a different story. It's important to remember that as the market anticipates the Fed raising rates, the yield curve typically begins to reflect that view by offering more yield for bonds directly affected by short-term rates as it is pricing in potential future rate hikes. That said, when the curve is fairly valued, it typically makes sense to buy bonds, even some longer-duration bonds.

[Beth]: That makes a lot of sense. Taking an active approach may offer opportunities to take advantage of those market inefficiencies.

[Mike]: Right, Beth. In our opinion, having the flexibility to position portfolios in light of market trends, avoid risky parts of the yield curve, and seek out investments that tend to perform better in a rising-rate environment makes the case for active fixed income management.

For listeners who want to learn more about this topic, view the accompanying report "Bonds in a Rising Rate Environment" on this page. We also encourage listeners to contact their investment professional to discuss the positioning of fixed income in their portfolios.

[Beth]: Thank you for joining us, Mike, to discuss how fixed income can play an important role in a well-diversified portfolio, specifically in a rising-rate environment. And thanks to our audience for joining us.