The Impact of Rising Interest Rates on our Portfolios
On Wednesday, December 14, the U.S. Federal Reserve Bank made the long anticipated decision to raise its policy rates by 0.25%. This is the first increase in a year and only the second increase within the past ten years. Federal Reserve Board Chairwoman, Janet Yellen, signaled that the strength of the labor market and the likely path of inflation could call for additional rate hikes in 2017 and beyond. What are the implications of rising interest rates for our portfolios?
A rising rate environment poses a challenge for bond investors. As interest rates rise, bond prices decline with long maturity bonds declining more than shorter term bonds. In anticipation of a rate increase we made adjustments earlier in the year to the Consolidated and Quaker Green Funds. We reduced our exposure to longer term bonds and intentionally lowered the duration of our fixed income allocations to mitigate downward pressure from declining bond prices.
Our Short Term Investment Fund (STIF) is structured with shorter bonds that mature in less than two years. This fund is an ideal solution for constituents looking to invest funds that are needed in a one to four year time frame. In addition to being less volatile than longer term bonds, the shorter term structure means that maturing bonds are reinvested in progressively higher interest rates allowing investors to participate in the upward move in rates.
Domestic equities have experienced a seven year bull market and they continue to move higher on expectations of fiscal stimulation and a business friendly Trump Administration. Historically, the S&P 500 tends to perform well in the 12-month period following a new round of rate hikes. Given the current state of the domestic economy and the Fed’s optimism on future growth conditions are favorable for equities to withstand a moderate rise in interest rates.
As part of a class of high yielding equities, Real Estate Investment Trusts (REITS) have been popular with investors seeking higher income over the past few years. While REITS have been the best performing asset class in the Consolidated Fund since 2013, they can be negatively impacted as interest rates rise and investors move into less risky assets. Over the past 12 months we proactively reduced REIT exposure from an overweight position as it appeared likely that the Fed would soon be raising interest rates.
While the Federal Reserve Bank’s decision to raise short term interest rates may create a shift in investor perception and increased volatility in the capital markets, our recent tactical moves in anticipation of this action should serve to protect our funds from collateral negative effects. Our well-diversified portfolios that focus on long term results should provide our investors with strong participation in up markets and offer downside protection when prospects diminish. Supported by academic and practical research studies, we are committed to broad asset diversification as the best defense against market uncertainty.
Richard Kent, CFA
Chief Investment Officer