Rates Rise, Values Fall – Where are we now?

By Darlene Duncan
Publish Date
March 25, 2024

Following the 2022 market, when nothing seemed to work and equities and fixed income moved in the same direction – DOWN – I read with great interest about the declared death of the balanced portfolio, particularly the 60/40 portfolio. Now in the recent press, it seems the 60/40 patient wasn’t dead after all, the balanced blend is back and once again being regarded as sensible for moderate growth investors.

I would argue that a blended portfolio was never dead, but instead, when inflation kicked up and rates began to rise, the fixed income allocation of the portfolio should have been invested differently. Investment Fundamentals 101 for Fixed Income securities – rates rise, fixed income values fall. The longer the maturity, the higher the duration, the lower the quality, the greater the loss in CMV. Those who had their fixed income allocation in traditional long term fixed income mutual funds or ETFs suffered the most. Why? Traditional fixed income funds have no set maturity date when principal is to be returned. Rising rates coupled with investors selling those holdings increased downward pressure on the fund prices. That is the worst scenario if you are a fixed income investor who is seeking preservation of principal.

If we learn best from experience, then I have learned a great deal over these many years in the investment business. Very early in my career, Ronald Reagan was President and Paul Volcker was the Fed Chair. It was a time of stagflation, high inflation, low economic growth, and high unemployment. Volker’s hawkish policy to tame inflation sent rates to unprecedented levels. Great experience if you were a CD buyer living on the interest, not so great for those who were sitting in long term bond funds (there were no ETFs back then). Fast forward to 2022 with inflation rising rapidly coupled with Fed tightening. Bond prices, especially long-term paper, got hit. I knew then to pull the 1982 playbook off the shelf, move away from funds and into laddered individual fixed income paper. “Transitory” or not, I learned early on in my career to control what you are able during times of uncertainty.

If you suffered losses on your fixed income portfolio in 2022, and perhaps have yet to recover those losses, you are not alone. Many highly regarded asset managers held long-term fixed income funds and were left flat footed. But those losses are not the fault of the bonds. After all, they behaved in a manner to be expected (i.e. rates rise, values fall). And it certainly wasn’t a reason to abandon the longstanding case for diversification and exclude bonds from portfolios. It wasn’t a matter of the wrong allocation; it was a matter of the wrong strategy.

What I love about bonds, and what you should love about them too, is that they are predictable, and yes, a bit boring. They help smooth out the ride for investors and provide a steady stream of income. Providing you have enough assets to allow for sufficient diversification, investing in a laddered portfolio of high quality, low duration bills/notes/bonds is an excellent strategy during times of rising interest rates. Based on a client’s needs and tolerance for risk, balanced portfolios are a mainstay of our Expressive Wealth investment models. If assets are sufficient to allow for acceptable diversification, owning individual fixed income securities and laddering maturities continues to be our strategy today for our blended portfolios. Rates will come down at some point and we will look to go back into an allocation of fixed income funds or ETFs, but that shift is not today.

Remember Harry Markowitz and the Modern Portfolio Theory? Markowitz’s Efficient Frontier shows risk/reward for optimal blends. Though not so modern these days, I believe the theory still has merit. You see, old Harry made a case for bonds too and won a Nobel prize for his Modern Portfolio Theory methodology.

The lesson of the death and resurrection of the blended portfolio is this. Get invested. Stay invested for the long term. Work with a trusted advisor who understands you and the markets.