Meyer uses several “go anywhere” alternative bond managers to try to reduce his vulnerability to higher rates and capture more yield than “a Plain Jane vanilla bond,” he says. Included in his portfolio are the Guggenheim Macro Opportunities Fund (GIOAX), the Osterweis Strategic Income Fund (OSTIX) and the Pimco Income Fund (PIMIX).
Seeking Balance
Gary Quinzel, a senior portfolio manager at AEPG Wealth Strategies in Warren, N.J., says the RIA has been very conscious the past few years about not over-stretching for yield (taking on too much credit risk to compensate for the low interest rate environment). But AEPG—like the other firms included in this article—takes a total return approach, is diversifying income across asset classes and has been preparing for higher rates for a long time, Quinzel says.
AEPG’s interest-rate outlook is tied to expectations for higher inflation. Quinzel and his colleagues think inflation will likely head north of 2% this year (exceeding the Fed’s target) because of higher wage growth, increased fiscal spending and, if they escalate, trade war tensions. To prepare, the firm is using the JPMorgan Inflation Managed Bond Fund (JRBSX) and a broad basket of long-only futures and commodity equities.
Stocks that previously performed well as bond proxies will “face continued headwinds as rates begin to rise,” says Quinzel. They’ll eventually be supported by investors’ move out of growth stocks and into value, but it’ll take a few more rate hikes and maybe a major geopolitical or economic event “to really spark that rotation,” he says.
He thinks such a transition could help more defensive sectors such as health care. But as higher rates impact future cash flows, he says, there may be further rotation out of high-growth sectors such as consumer discretionary and technology. And the flight from tech could hasten if Congress implements tougher privacy regulations, he adds.
However, “We really don’t make any sector bets,” says Quinzel. “It’s more of a broader look at growth versus value.”
Like Meyer Capital, AEPG has shortened its bond duration to try to dial back the impact of rising interest rates. “We also want to be active with our credit quality because we’re late in the [stock market] cycle,” says Steven Kaye, AEPG’s CEO and founder. Credit spreads are very narrow (so investors aren’t being compensated for taking greater risk) and high-quality bonds are more likely to hold up during times of stress, he says.
AEPG also invests in private real estate, which doesn’t fluctuate (as REITs do) with the daily volatility of the stock market. The firm’s investments are managed by a third-party real estate company and include multifamily, office, retail and warehouse properties.
Although AEPG has long been preparing its clients for rising rates, says Quinzel, “there is going to be a little bit of sticker shock” when they see negative returns on their bond portfolios. But history suggests these are short-term price losses, AEPG assures clients, and over the longer run the vast majority of total return from any fixed-income product comes from the yield component. As yields increase, “that’ll result in a higher return than if rates stayed the same,” he says.