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Investing in Rising Rate Environments

I love all the banter about how all the famous investors like: The Dutch Pension, Calpers, etc. have announced that they are leaving the hedge fund space. The question is: Why?

The relative performance of hedge funds vs the S&P is poor. Is that the reason? Probably, but that is comparing apples and oranges. Maintaining the allocation is critical to maintaining the correct volatility  for the overall portfolio structure. When firms announce they are leaving a complete asset class, it tells me they are not disciplined, performance chasing and are not paying attention to risk.

That would make any pensioner uncomfortable. So let’s dig deeper into a scenario that Granite Group Advisors will unfold over the next few years:

Granite Group believes all that interest rates will go up slowly over a long period of time. As investors, how do we prepare ourselves for a rise in interest rates? To find suitable allocation without increasing risk, let's take a useful look at the past.

Russell Investments conducted a study of the 10-Year Treasury yield over the last 45 years. Since 1970, we've seen 11 periods of rising rates lasting at least 6 months. Cumulatively, rates have gone up for a total of 18.2 years and rates fell for a total of 26.8 years. On average, U.S. stocks performed slightly worse during periods of rising rates (9.7%) than in periods of falling rates (10.7%). Consider these three interesting facts.

  1. Long-term US bonds (20+ years to maturity) lost an average of 7% a year in rising rate environments, compared to the overall bond market losing an average of 1% a year. When rates start moving up again, long-term bonds are expected to take the hardest hit, and the numbers bear it out. So if your are in low risk bond fund, what would be a suitable replacement without affecting overall volatility and
  2. International stocks outperformed U.S. stocks by a significant margin in times of rising rates, 17% vs. 9% per year. Looking at the 2 longest periods of rate increases, December 1971 to September 1975, and January 1977 to February 1980, international stocks outperformed U.S. stocks, 5% vs. 1% and 20% vs. 9% per year, respectively.
  3. Commodities, especially oil and gold, showed superior returns in rising rate environments vs. falling rate environments, to the tune of 19% vs. 2% per year. The price of oil has dropped 54% in the last 6 months (it's like a revelation every time I fill up at the pump), and gold prices have dropped 30% over the last 3 years. For those who have a tolerance for risk, this may be a good time to consider commodities as an investment.

Keep these three facts in mind as we progress through the year. That being said, past performance is not indicative of future results! But it's good to know what worked and what didn't when rates rose in the past.


Ask Granite Group about how we're preparing our clients for an impending rise in interest rates

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