The Federal Reserve’s shift toward higher interest rates presents advisors with competing considerations as they help clients position their fixed income investments. While rising rates can put downward pressure on existing bond prices, they open opportunities to secure higher yields. Advisors must weigh those opportunities against each client’s cash flow needs, investment horizons and ability to tolerate changes in portfolio value.
We spoke with Chris Gunster, Partner and Head of Fixed Income at Fidelis Capital; Nick Holuta, Senior Vice President, Investments and Portfolio Manager at Dynasty Financial Partners; and Seth Hickle, Chief Investment Officer at Mindset Wealth Management, about balancing those opportunities with clients’ goals and investment horizons.
We asked each of them: “Given that the Fed has started tightening interest rates and appears to be setting up for an environment of rising rates, what should advisors do to help clients adjust their fixed income strategies and allocations to the new environment?”
Their responses follow.
Gunster: It’s important to understand how many interest rate hikes the market is anticipating, where real rates are, and what yield cushion is priced into bonds.
The market is now anticipating three 0.25% interest rate hikes between now and the end of 2027. If that’s the case, this would be one of the shortest tightening cycles the Fed has embarked on. And if upcoming Fed decisions match current expectations, then the impact to longer‑term rates may be negligible, if not lower. For some investors, this may be a good opportunity to increase their bond allocation.
Real Treasury yields are high on a relative basis. The overall rates environment is very attractive historically, particularly in longer‑maturity bonds.
The yield cushion in bonds is high. For example, interest rates for a 5‑year Treasury would have to increase by over 1.00% before the expected 12‑month total return of the bond turns negative. That’s a big yield cushion.
Notably, the recent selloff in bonds made municipal bonds very attractive for those in the highest marginal federal tax rate.
Don’t avoid bonds just because the Fed may raise rates by 0.75% over the next 14 months. Focus on the current yields available in the market — they are attractive by many metrics.
Holuta: The Fed raised rates by 25 basis points in September, and the market is pricing in another hike as likely by year end. Even so, we think duration looks attractive here, and we would encourage advisors to think twice before shortening portfolios simply because the Fed is tightening. The move was widely anticipated, and with yields where they are today, we believe investors are being paid well to own fixed income, near levels not seen since the Global Financial Crisis.
In practice, we think it’s worthwhile for advisors to review how much interest rate sensitivity clients hold and compare it with their goals and time horizon. Where portfolios sit short of that target, we would extend gradually and stage purchases over several months, which helps manage the risk that rates continue to move higher in the near term. High quality core bonds can also provide ballast if growth slows, which matters most for clients with heavy equity exposure.
Finally, we would remind clients that higher yields raise the income earned on reinvested coupons, which supports returns over a full cycle even when bond prices dip in the near term.
Hickle: Advisors should be more intentional with their fixed income allocations. The days of buying a broad‑based bond index and simply expecting stability are over. Duration matters, and when rates rise, holding longer‑duration bonds can be quite painful. Recently, we have been favoring the shorter end of the yield curve to position fixed income assets as an attempt to limit sensitivity to further rate hikes.
However, investors shouldn’t abandon duration altogether. Building a laddered fixed income portfolio in a rising‑rate environment can provide opportunities to reinvest maturing proceeds at higher yields as the rate cycle progresses. For investors who rely on fixed income to generate cash flow, rising interest rates present an opportunity to lock in attractive yields at levels we haven’t seen in years. The key is finding the right balance between protecting capital today and positioning portfolios to take advantage of opportunities as the interest rate environment evolves.
Jeff Berman, Contributing Editor and Reporter at Wealth Solutions Report, can be reached at jeff.berman@wealthsolutionsreport.com.
