Investing means taking calculated risks, but nobody should have to lose sleep over it. If your portfolio is keeping you up nights, it may be time to consider a low-volatility strategy.
No matter what country they call home, investors who need their portfolios to generate steady income know they have to take some risk to get returns. But markets have grown more volatile and less predictable this year, and high-income assets are usually the first to sell off when sentiment sours or the market outlook changes.
Yet pulling out of high-income sectors altogether isn’t an option for most of us—particularly when income is so hard to come by. So how can investors stay the course and generate the income they need without taking undue risk?
Our research shows that high-quality, short-duration bonds have over time dampened portfolio volatility and held up better in down markets.
What’s the secret? A lot of it has to do with duration, a measure of a bond’s sensitivity to changes in its yield. In general, bonds are highly sensitive to yield changes—when yields rise, prices fall. The shorter the duration, the less damage a rise in yields will do.
For most investment-grade bonds, yield changes are driven primarily by changes to interest rates, or the yields on government bonds. High-yield bonds, though, are less sensitive to interest-rate changes than other types of bonds. But yields can rise for a number of reasons. When concern about global growth and falling commodity prices hit high-yield bond markets hard earlier this year, the shorter-duration bonds held up best.
Like any strategy, a short-duration one can lose money in down markets—but it generally loses much less than strategies with higher duration and additional risk.
Riding The Asset-allocation Seesaw
In up markets, on the other hand, investors who follow a short-duration strategy give up some return in exchange for a smoother ride—but not as much as they might think. To understand why, it can help to think of one’s various investment options as an asset-allocation seesaw, with cash in the middle; interest-rate sensitive assets, which do well in “risk-off” environments, on the left; and return-seeking assets, which thrive when investor risk appetite is high, on the right (Display 1).
