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Chuck Jaffe
April 7, 2010, 1:46 a.m. EDT · Recommend · Post:
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Three questions to ask of a top-performing fund
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By Chuck Jaffe, MarketWatch
BOSTON (MarketWatch) -- It hasn't been so long since the last time interest rates went up, but it sure feels that way.
So with many investors now convinced that a rate hike is in the offing, it makes sense to consider what changes, if any, you should make to your portfolio. Truth is, one rate hike -- if and when it happens -- is a headline event, not something that demands immediate reaction. Only after a second move, or maybe a third, will rising rates warrant a response from the average investor.
As the economy improves, rate hikes loom, says Michael Cuggino, manager of the Permanent Portfolio fund family. He tells Jonathan Burton how stock and bond investors can blunt the impact of rising rates and take advantage of global growth.
To understand why, look at two important factors: inflation and the Federal Reserve.
While there are plenty of inflation fears for the economy, it's hard to have much inflation at a time of high unemployment and no wage pressure to drive costs up. Inflation will come later, rather than sooner, as the economy needs to unwind some other concerns first.
Then there is the Federal Reserve, which has a long history of making protracted rate moves, but no recent history of short, small, one-time steps.
Investors may remember the 2004-2006 stretch, where the Fed responded to low rates by raising them at every meeting like clockwork. What you don't find from the Fed is a "one-and-done," a move to show some backbone -- and perhaps a willingness to step back from the extreme edge of near-zero rates -- without any follow-up.
Just as important, there is the very real concern of how rising rates could derail economic recovery. The 10-year Treasury yield has been hovering near 4% recently; it could jump to 4.25% if the Fed raises other rates and the market responds broadly. But a 10-year Treasury with a yield much above 4.25% could hamper the budding recovery in the housing market, which could stall overall growth.
"There's a lot of people talking about how rates are going to go up, but I'm not a real believer that we'll see rates going much higher and staying there," said Les Nanberg of Cornerstone Wealth Management in Boston, the former chief economist and head of fixed income investments at mutual-fund giant MFS. "These are not the conditions that have driven rate moves in the past, so I don't think you want to overreact to a small rate increase, if one happens soon."
Indeed, for many investors, the impact of a rate increase will be negligible and temporary. Investors in money-market funds, for example, can expect that fund management will keep the bulk of a rate hike for itself, recapturing fee waivers that have allowed it to deliver positive returns while rates were practically zero. See related story on money-market fund fees.
Peter Crane of Crane Data, which publishes Money Fund Intelligence, said that money fund costs have dropped to 0.25% from roughly 0.4% thanks to waivers that funds put in place in order to keep returns positive. If there is a rate hike, he expects the funds to grab back most of their pay before passing it along to investors.
"Of a quarter-point hike, investors will probably split that with the fund company," Crane said. "It will take two hikes to remove the fee waivers entirely, assuming quarter-point increases. The Fed has never made just one increase -- they have always taken one step and then another and another -- but investors won't really start to feel a difference in their money-fund returns until you get to the second increase, or maybe the third."
By comparison, investors in bond funds could feel the pinch of a rate hike immediately. Bond funds suffer when rates are on the rise. When yields go up, bond prices fall, and since the fund must be priced at the end of each day based on what it could get if it sold all of its holdings, those falling bond prices tend to throw bond funds for a loop -- an unpleasant surprise for safety-conscious investors.
Charles Groeschell, one of the portfolio managers for the Baird Aggregate Bond Fund /quotes/comstock/10r!bagsx (BAGSX 10.57, +0.01, +0.09%) , noted that investors will feel this pinch less in short- and intermediate-term bond funds, but warned that the big danger could be in municipal-bond funds that have been chasing yield by going after longer-term paper.
"There are so many muni funds that focus on income, and they focus on being very long in average maturity and duration," Groeschell said. "A lot of those muni income-oriented funds are going to be very long in average maturity and duration, and those are the ones where there could be a very unwanted negative surprise for the holders out there."
Because rising rates create short-term pain in bond funds, one school of thought suggests that investors should hold funds when rates are rising, but buy the individual paper when rates are falling. For shareholders who have stuck with funds during the rate decline, the last few years have proven more volatile than historic norms; knowing the duration of a fund's securities -- and trying to limit exposure to long-term paper -- will be key to avoiding the short-term bruises that are likely if and when rates rise.
Savers will find some immediate benefit to rate increases in savings account and certificate-of-deposit rates, but won't want to lock in anything long-term until they see if a rate increase is that unusual once-and-done move or if there are secondary steps to follow.
"You may be able to do some opportunistic investing, like if the 10-year Treasury gets to 4.25% it's at a level you might want to buy," said Nanberg, "but I don't think any strong move up in rates is sustainable, it's not something that will make investors want to move money around."
Chuck Jaffe is a senior MarketWatch columnist. His work appears in many U.S. newspapers.
Chuck Jaffe is a senior columnist for MarketWatch. Through syndication in newspapers, his "Your Funds" column is the most widely read feature on mutual fund investing in America. He also writes a general-interest personal finance column and the Stupid Investment of the Week column. Chuck does two weekly podcasts for MarketWatch, and frequently makes guest appearances on television, and on radio shows across the country. He is the author of three personal-finance books, with his latest, "Getting Started in Hiring Financial Advisors," set to be published in the spring of 2010 by John Wiley & Sons.
Duke University wasn't the only big winner Monday night. CBS had a triumphant night as well, attaining its highest level of viewers in 13 years for a March Madness championship game, reports Jon Friedman.
7:11 p.m. April 6, 2010 | Comments: 3
- AmericanPatriot | 1:27 a.m. Today1:27 a.m. April 7, 2010
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