Content provided by Josh Jenkins, CLS Investment Research Analyst

With the Federal Reserve moving closer to the seemingly inevitable liftoff in interest rates, one thing on the mind of many investors is, “How will this affect my portfolio?” This is particularly true for those invested in an income-oriented strategy. Generally speaking, all income strategies carry some level of interest rate risk, and can therefore be negatively impacted when rates rise. CLS attempts to mitigate this risk within its income strategies through several approaches, including:

  • Utilization of a globally diversified multi-asset allocation
  • Management of duration
  • Exposure to variable-rate securities

A globally diversified multi-asset allocation can help reduce interest rate risk in several ways. First, investing internationally provides exposure to countries engaged in different monetary policies. For example, the U.S. is currently moving towards a tightening of policy, but many other countries are actively easing their monetary policies. In addition, various asset classes, such as stocks, bonds, REITs, master-limited partnerships, etc., have differing levels of sensitivity to changes in interest rates. This happens in part because the return of one asset class may be impacted by other factors that do not affect another asset class in the same way. For example, MLPs are sensitive to the price of oil, stocks to the level of earnings growth, and corporate bonds to credit spreads. Combining assets whose prices are driven by different factors creates diversification and will generally reduce volatility and sensitivity to any one factor, including interest rates.

Duration is a key concept when thinking about interest rate risk because it represents a mathematically derived estimate of a bond’s sensitivity to interest rates. The higher a portfolio’s duration, the worse it will perform in a rising rate environment. Duration is closely related to the length of maturity and level of income paid. The longer the term to maturity and lower the income, the higher the duration. Currently, CLS’s Income Strategies have substantially lower durations than the Barclays Aggregate Index, which represents a good benchmark for the overall domestic investment-grade bond market.

Finally, exposure to variable-rate securities can be a great tool in reducing interest rate risk. Bonds and other bond-like investments, such as preferred stocks, bank loans, and convertibles, either pay interest at a fixed rate or a floating rate. The price of a bond that pays a fixed rate decreases when interest rates increase because newly issued bonds will pay the new, higher rate. The price of a bond that pays a floating rate will not fall when interest rates rise because its coupon will be adjusted upward with the increase in interest rates. The Income Strategies at CLS have substantial exposure to floating-rate securities.

Unfortunately, income investors cannot eliminate their portfolio’s sensitivity to rate movements altogether, as doing so would likely prevent them from generating their required level of income. A superior alternative would be a multi-faceted approach centered on a globally diversified multi-asset portfolio, management of duration, and utilization of variable-rate securities.


The views expressed herein are exclusively those of CLS Investments, LLC, and are not meant as investment advice and are subject to change.  No part of this report may be reproduced in any manner without the express written permission of CLS Investments, LLC.  Information contained herein is derived from sources we believe to be reliable, however, we do not represent that this information is complete or accurate and it should not be relied upon as such.  All opinions expressed herein are subject to change without notice.  This information is prepared for general information only.  It does not have regard to the specific investment objectives, financial situation and the particular needs of any specific person who may receive this report.  You should seek financial advice regarding the appropriateness of investing in any security or investment strategy discussed or recom­mended in this report and should understand that statements regarding fu­ture prospects may not be realized.  You should note that security values may fluctuate and that each security’s price or value may rise or fall.  Accordingly, investors may receive back less than originally invested.  Past performance is not a guide to future performance.  Investing in any security involves certain systematic risks including, but not limited to, market risk, interest-rate risk, inflation risk, and event risk.  These risks are in addition to any unsystematic risks associated with particular investment styles or strategies.
An income-generating asset is one which seeks to provide a return on investment by taking positions in various securities designed to grow principal.  Specific securities selected to achieve this goal may vary greatly.  Diversifiable risks do exist but vary based on the specific securities chosen.  One over-arching diversifiable risk is the liquidity risk. A Master Limited Partnership (MLP) is a partnership which is publicly traded with at least 90% of capital coming from real estate, natural resources, and commodities.  As such, MLPs are subject to all of the underlying risks of these investments. Real Estate Investment Trusts (REITs) are subject to decreases in value, adverse economic conditions, overbuilding, competition, fluctuations in rental income, and fluctuations in property taxes and operating expenses. The Barclay’s Capital U.S. Aggregate Bond® Index measures the performance of the total United States investment-grade bond market.  An index is an unmanaged group of stocks considered to be representative of different segments of the stock market in general.  You cannot invest directly in an index.