Preparing the Stable High Yield Portfolio for higher rates

The Stable High Yield portfolio has lagged the Barclay’s U.S. Aggregate Bond Index over the past year, primarily because of the decline of its mortgage real estate investment trust holdings in the first half of 2013.

Those mREITS were sold by the mid-summer of 2013, after having incurred, in my opinion, the damaging effects of Fed Chairman Ben Bernanke’s now-infamous taper talk last spring.

Of course, we do have our theretofore heavy mREIT exposure to thank for the portfolio’s since-inception total return of 5% vs. 3.3% for the AGG during that same period.

At the present time, the portfolio has taken on a defensive posture due to the inevitable rise in interest rates. Are we too early to be defensive? Perhaps. But the time to react to a rise in rates is not after they have already risen; it’s before they begin to rise.

Sure, many of us have been crying wolf about increasing rates for more than a year now, but that doesn’t lessen the inevitability. Higher rates are coming, sooner or later, and it’s more prudent to bet on sooner than later.

What’s important now is to be not out of position when it happens. Our holdings are thus constituted to seek price stability (via low duration), while potentially delivering a return in the area of 2%-4%.  With an economy that will likely be improving when rates rise, we’ll accept more credit risk than interest-rate risk at this time.

DISCLAIMER: The reader should not assume that any investments identified were or will be profitable or that any investment recommendations or investment decisions we make in the future will be profitable. Investments in securities of small-cap and growth companies may be especially volatile. Past performance is no guarantee of future results.