Four Ways to Fight Back as Rates Rip Higher

Mike’s Moves to Make Buy: Floating-rate, interest-rate hedged, short-term, low-duration bond funds and ETFs Sell: Long-term, high-duration government, municipal, and emerging-market bonds and funds

I don’t know about you. But I’m still stuffed! Turkey, ham, casseroles, salads, rolls, and birthday cake to boot … it was a heck of a holiday at the Larson house yesterday, and I hope your Thanksgiving was just as enjoyable as ours.

Now, let’s talk about what you’re probably NOT thankful for, at least if your primary investment goal is income. I’m talking the impact of interest rates, which have been absolutely ripping higher. Consider:

The yield on the 5-year Treasury Note has more than doubled, hitting 1.88% on Wednesday after bottoming out at 0.91% in early July. If it rises just a few more basis points, it’ll be at its highest since the spring of 2011.

Meanwhile, the 10-year Note has risen more than 100 straight basis points, jumping to 2.42% from 1.34%. And the 30-year yield has climbed to around 3.09% from 2.1%.

Since rising rates drive bond prices lower, these moves are wreaking havoc on fixed-income funds of all shapes and sizes. Many retirees like to invest in municipal bonds for safe income. But the benchmark iShares National Muni Bond ETF (MUB) has dropped more than 4% in the last three months thanks to rising interest rates.

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Foreign bonds have attracted billions of dollars from investors seeking higher yields than U.S. bonds offer. But the post-election surge in interest rates and the rise in the value of the U.S. dollar have caused the PowerShares Emerging Markets Sovereign Debt Portfolio (PCY) to lose almost 8% in the last three months.

So-called “safe” Treasuries have been anything but, too. The iShares 20+ Year Treasury Bond ETF (TLT) has dropped almost 13% since August, while the Vanguard Extended Duration Treasury ETF (EDV) has tanked 18%.

Real estate has traditionally been a safe haven investment – but not anymore.

Other income alternatives touted on Wall Street (but panned as extremely risky by me on several occasions haven’t done much better. The benchmark iShares U.S. Real Estate ETF (IYR) has shed more than 10% of its value in the past three months. That’s enough to wipe out the IYR’s 3.8% dividend yield more than two-and-a-half-times over.

So what can you do? Where can you still get relatively safe, reliable income – even in a rising-rate environment?

Naturally, my best ideas can be found in my Safe Money Report. I recommend specific stock and bond investments, and provide “buy” and “sell” targets, there, and I’d love to have you on board. You can sign up by clicking here.

But if you’re not quite ready to take that step yet, here are four general categories of investments that can help you fight back against rising rates:

1. Highly rated, fundamentally strong stocks that can grow their dividends – Rising rates are bad news for many stocks that get lumped into the category of “bond alternatives.” That includes REITs, utilities, lower-growth telecommunications companies, and the like.

But even in sectors like telecom and utilities, there are companies that can sustainably grow their dividends thanks to rising sales and earnings. And outside of those sectors, there are some stocks that feature the right combination of high Weiss Ratings and strong fundamentals, as well as less exposure to the turn in the credit cycle, which I’ve discussed for many months. It’s those “A” and “B” rated names that you can (and should) focus on.

2. Floating-rate funds – In the bond world, you can now find an increasing number of ETFs that allow you to invest in floating-rate bonds. As the name suggests, these are corporate bonds whose coupon payments adjust higher when benchmark short-term rates rise. You still have credit risk, because corporate borrowers can default. But you’re heavily protected against interest-rate risk.

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One example would be the iShares Floating Rate Bond ETF (FLOT). It has assets of $3.5 billion, and sports an effective duration of just 0.14 years. Duration is a measure of interest rate risk; the higher the number, the more money you’ll lose as rates rise, and vice versa. That EDV fund I mentioned earlier features an average duration of 24.6 years – a key reason why it just plunged 18%.

3. Interest-rate hedged funds – We’re also seeing more ETFs that use interest rate derivatives and futures to eliminate as much rate risk as possible. The ProShares Investment Grade – Interest Rate Hedged ETF (IGHG) is a $136 million fund that “shorts” Treasury futures to hedge out rate risk. That allows you to profit from corporate bonds without worrying that rising rates will torpedo your portfolio.

4. Short-term/low-duration funds – Rather than own long-term munis, Treasuries that don’t mature for several years, REITs, or other vulnerable income-generating investments, you can also just stick with ETFs or funds that own short-term, low-duration debt. For instance, the iShares 1-3 Year Treasury Bond ETF (SHY) is much safer in a rising-rate environment than the TLT because it owns 1-to-3-year debt, rather than bonds that mature in 20 or more years.

Of course, this is just a partial list of strategies. I have many, many more in my toolbox, seeing as I’ve spent the last couple of decades focusing on the interest rate markets and shifts in the credit cycle. So keep your eyes out for more guidance here in Money and Markets and in my Safe Money Report in the weeks and months ahead.

Above all, don’t underestimate the significance of big rate shifts like those we’re seeing now. I can tell you from experience that the absolute worst approach is to ignore them, freeze up, or otherwise fail to react in sensible, safe, and prudent ways.

Have a great Thanksgiving holiday weekend, and I’ll be back again soon.

Until next time,

Mike Larson