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Rates Rise, Then What?

Given our current position on the credit cycle, below investment grade bonds and structured credit are great places to be. Default rates remain low during periods of high accommodation from the Federal Reserve, such as the present one. What should investors be considering when they are selecting below investment grade securities and asset-backed securities? Floating rate assets are ideal because the coupons will rise with the eventual increase in interest rates that will occur when the Fed begins to tighten. Because we do not know when that will occur, a substantial allocation to floating rate assets can hedge the risk around this uncertainty.

Investors should also stay in relatively short duration fixed rate debt. For those who do not have this as an option, such as insurers or pension funds, I would encourage a barbell strategy. That way even if they are holding long duration assets, as interest rates move up, they can sell their short duration holdings at a modest profit or loss and reinvest in longer duration assets once rates have risen.