What’s the Deal With Interest Rates?

As I write this, I just got a mortgage for 2.75%, my student loans are about to get refinanced at 1.5%, and my auto loan is 0%. And as a consumer, you might think ultra-low interest rates are the greatest thing since sliced bread. That might be true for consumers, but for investors looking for low-risk and a decent return, not so much. A couple of things to start you off:

• The Federal Reserve controls interest rates. Congress and the executive branch do not. That separation is a good thing.
• The yield on a bond is how much income you’re being paid. If a $100 bond has 3% yield, you get $3 per year.

The decline in interest rates has led to higher returns in many bond portfolios (prices move inversely to yields; yields go down, prices go up), but what now? The bond index yields a stunning 1.3%. The 10-year US treasury bond is clocking in around 0.7% to 0.8%. Not many investors are looking to lock in for 10 years at 0.7%.

To be clear, we manage our portfolios to produce a bit more income than the bond index and the 10-year Treasury bond, but we have to be careful. If we reach too far out on the income spectrum, our clients end up owning some low-quality rated bonds; i.e. when your stocks go down, your bonds are going right down with them. So, what does all of this mean for portfolio management going forward?

Well, after having discussion after discussion in our Investment Committee:

1. Bonds are still very important to own and the vast majority of our clients should still own them.
2. We may have to simply accept less income and lower returns for quite some time.
3. Bonds may not provide as much “cushion” during stock market sell-offs going forward.
4. Consequently, the need for strong risk management in our stock portfolios has never been greater.

That last point is important. There are ways we can reduce risk by simply owning less risky stocks and selecting good fund managers. What are less risky stocks? Think of consumer staples like utilities and infrastructure – in good times and bad, people generally need food, electricity, and water.

What about selecting fund managers? To say our manager selection process is rigorous would be an understatement. Before we even sit down to meet with a fund manager or their analysts, we’ve already stress-tested them across three different software analytics tools, reviewed their performance and risk metrics in detail, and after that, reviewed and stress-tested them again to see how they would perform with other funds our clients own. All of this is a long-winded way of saying you may see some shifts in your portfolios as markets evolve. We are constantly thinking about risk, stress-testing our portfolios, and looking for new investment opportunities, all while staying mindful that we are helping our clients achieve their financial goals.

As always, if you have questions about your portfolio or risk tolerance, give us a call at 701.235.2002 or send us an email at info@heartlandtrust.com. We’re always here to help and look out for your best interests.