CHICAGO (Reuters) – As the financial markets await more signals on the Federal Reserve’s interest-rate policy next year, which may push rates higher in early 2015, it wouldn’t hurt to take a close look at alternative bond funds.
Unlike conventional bond index funds, which may hold static portfolios, “unconstrained” or “hedged” funds are able to be nimble when rates rise. Although they may not totally avoid losses that could come with rising rates, they could avoid some of the volatility. Ten bond dealers out of 17 polled by Reuters see the Fed raising rates in the second half of 2015, with another four saying increases would not start until 2016.
Last Friday, Charles Evans, president of the Federal Reserve Bank of Chicago, said eventual rate hikes would likely follow a “shallower path of increases.”
One way of avoiding losses in your income portfolio is to shorten maturities of the single bonds you’re buying or shorten durations in the bond funds you own. Duration is a measure of interest-rate risk. If your fund has a duration of 3, you could lose 3 percent if rates climb one percentage point.
Another worthy consideration are bond funds that hedge interest-rate risk or have the ability to shift their portfolios into less-volatile bonds.