We continue to see positive signs from the U.S. economy. Economic growth remains steady, inflation is contained and employment statistics indicate that the Federal Reserve is making great progress in satisfying its dual mandate of price stability and full employment. Markets are therefore anticipating an end to the “easy money” regime, and it’s likely the Federal Reserve will begin to increase interest rates sometime in the second half of 2015.
As we discussed in our 2013 newsletter article entitled Bond Buyers Beware, an unfriendly Fed will make fixed income markets a less hospitable place. In anticipation of these changes, we believe it is time to make the following shifts in our asset allocation portfolios:
First shift: We have slightly increased our equity allocation, as we believe that stocks offer greater long-term value than bonds.
Second shift: We have trimmed our exposure to agency mortgages (Ginnie Maes), due to the negative impact rising interest rates have on longer-dated mortgages.
Third shift: We have added a “core” investment grade bond strategy, to act as an anchor in the portfolio. In the event that the economy overheats, we will rotate more assets into this sector for downside protection.
Fourth shift: We have added a third investment strategy to our fixed income category. This new category is an unconstrained opportunistic fixed income manager. This manager has the ability to invest freely in higher yielding sectors, including floating rate notes. Floating rate securities are less sensitive to rising rates. Funding for this strategy is coming from trimming High Yield and World Bonds.
The goal of each shift is to reduce overall portfolio sensitivity to moderate increases in interest rates, while adding yield “cushions” and slightly boosting equity exposure. Please don’t hesitate to call your consultant if you have any questions about these changes.