How to Fed-proof your bond holdings in a rising interest rate environment

The Federal Reserve has signaled that it is likely to start raising interest rates this year. Bond investors have been expecting this eventuality for several years, but this time it looks like an impending reality.

What action should you take as a bond investor to best manage your bond portfolio in the face of rising interest rates? Bonds tend to be sensitive to rate changes. This is especially true of bond funds, which get a double whammy when skittish investors flee, leaving fund managers scrambling to redeem shares at the wrong time.

Remember: Bonds will decline in value, but their moves tend to be small compared with other securities.

“One thing that investors need to understand about the high-quality, fixed-income market is that our market is dominated by institutional players who are often insensitive to the level of interest rates,” says Pramod Atluri, co-manager of the Fidelity Total Bond exchange-traded fund.

A lot of these institutional investors are flooding into U.S. Treasury bonds, making the so-called flight to quality, because the U.S. looks better relative to other economies worldwide.

This higher demand means that the Federal Reserve’s actions aimed at raising short-term interest rates, which it directly influences, are less likely to have an impact higher up the yield curve on medium- or longer-term bonds, where rates are influenced more by investor expectations, says Atluri.