Interest rate risk is a concern for investors, what is CLS doing to manage this risk?
Rusty Vanneman, CFA
We entered the year concerned about interest rate risk. We have done a few things about it. First, one of our investment themes is “Creative Diversification.” This means that we are expanding the ways we can diversify portfolios without using as much traditional, investment grade bond exposure. We have used non-traditional fixed income (such as bank loans), alternatives (such as managed futures), and have been creative in portfolio construction (such as using low-volatility securities or even short positions). Second, we have reduced the interest rate sensitivity of our portfolios – essentially cutting our “duration” in half during the months before the interest spike we’ve seen over the last several months. This all said, with the strong rise in interest rates of late, our over-all conviction that rates will continue to rise in the months ahead has decreased.
Scott Kubie, CFA
In early May of this year the 10-year treasury yield dipped to 1.63 percent. Then it exploded to over 2.90 percent in a matter of months. Moves of this magnitude can’t be timed easily. Portfolios needed to be ready in advance for the potential of a move. While there have been quarters where rates fell, we stayed the course and limited our exposure to prudent levels. Now that yields have risen, we should be asking two questions: “How can our team manage interest rate risk better?” and “What opportunities exist for our clients because of the higher yields?”
Currently we are positioned in shorter duration fixed income ETFs. Bonds that have shorter maturities do better in periods of rising rates. In addition, we have diversified our fixed income exposure to incorporate floating rate debt and senior bank loans, which have less interest rate sensitivity than other bonds. These types of instruments are composed of bonds in which the coupon payments change based on prevailing short-term interest rates. Senior bank loans yield around 5 percent while holding minimal interest rate risk, however, they do carry higher credit risk. With default rates below the historical average, we feel that this is a nice way to earn additional income and mitigate the risk of rising rates in our portfolios.
Kostya EtusWe have shifted our equity sector allocations. We have reduced our exposure to defensive sectors including Telecom and Utilities, which tend to have high dividend yields, high levels of debt, and low cash positions; all factors that make them highly sensitive to interest rate moves. We have increased our weighting in growth oriented cyclical sectors such as Technology, which have less exposure to rate shifts.