Month: May 2017

Although interest rates fell precipitously in the early 1980s, they are now on the rise through the Federal Reserve System. Higher rates will resonate through virtually every sector of the economy, including investments; more specifically, the increasing interest rates can be bad for bonds. And many fixed-income investors are asking where they should turn.

When interest rates rise, new bonds pay a higher yield, which is good for new bond buyers. But it’s bad for existing bondholders, because their bonds, which pay less interest, are less attractive and therefore decline in price.

Variable rate instruments

Investors who are concerned about the potential impact of higher interest rates on their existing portfolios have options in variable rate instruments, which are securities that do not offer a fixed rate of interest. The rate of interest they pay varies over time.

Floating-rate securities

One such instrument is the floating-rate security. Floating-rate securities are typically issued by investment-grade companies with solid credit ratings. They have interest rates that are tied to an index and reset periodically. So if interest rates rise, floating-rate securities tend to pay a higher interest rate starting with the next reset date. The downside: floating-rate securities may offer yields lower than fixed-rate bonds of the same maturity offered by the same issuer.

Bank loans

Bank loans are also variable rate investment vehicles, with rates that usually reset every 30, 60, or 90 days. These tend to offer a higher interest rate, but also may carry a greater credit risk than investment-grade floating-rate securities.

In a declining interest-rate environment, variable-rate instruments such as floating-rate securities and bank loans can be poor investment choices. But in stable and rising-rate environments, they may offer a measure of protection against increasing interest rates. Discuss with your advisor whether variable-rate instruments are right for you, given your financial situation and investment goals.

Developing countries, also known as emerging markets, may be an appealing investment option to certain investors.

The four largest emerging markets by gross domestic product are the so-called BRIC countries: Brazil, Russia, India, and China. However, there are other large emerging markets, including Mexico, Indonesia, Turkey, and Saudi Arabia.

In the past few years, emerging markets have disappointed investors; stocks have been restrained by a number of factors, including weak commodity prices and political disruptions. However, in 2016, this trend reversed. Now investors seeking international diversification in their portfolios are wondering if they should look again at emerging markets. There may be solid reasons why they should.

A number of factors support positive emerging-market performance. The Chinese economy has stabilized as a result of early 2016 stimulus. Commodity prices are more supportive than they have been in the past. And in many emerging markets, developing middle classes are driving growth.

On the other hand, the potential impact of rising interest rates and a stronger U.S. dollar is a big concern for those considering investments in emerging markets, although in many previous rate-hike cycles, the U.S. dollar has rallied through first interest-rate hikes, then sold off. Certainly, risks must be monitored. For any lasting recovery to occur, there will need to be a stabilization of corporate earnings in emerging market countries.

On balance, however, emerging markets may be back as an interesting investment option for suitable investors.