Prudential PGIM Thematic Pages

Positioning Portfolios for Rising Rates

Rising rates present a significant challenge for investors, especially for those whose portfolios contain exposure to interest-rate-sensitive investments.

The Trend Rates are on the Rise

Rising rates can have a lasting impact on investment portfolios, which makes now a good time to examine portfolio allocations and identify where adjustments might be needed.

Consider strategies designed to help manage duration, generate yield, and diversify exposure.

A Look Back How often do interest rates rise?

Since 2000, there have been six periods where the 10-Year U.S. Treasury yield rose by 75 basis points or more. Select a rate period below to see more details.

Yield (%) 7 6 5 4 3 2 1 0
| Dec 00 Dec 17 |

Source: Bloomberg, Morningstar, and Federal Reserve Economic Data as of 12/31/17.

A Look Back Strong performing asset classes

Fixed Income

Due to their inverse relationship, rising rates typically reduce the price of bond assets. Historically, less interest-rate-sensitive assets with shorter duration or floating rates have provided better total returns in rising rate periods.

Fixed Income Chart 17.7% Short Duration High Yield 11.0% Floating Rate Loan 6.3% Non-traditional Bond 1.6% U.S. Bond
Fixed Income
Equities
Equity Chart 26.6% Small Cap Equity 21.7% Int’l Equity 19.6% Global Equity 17.7% U.S. Equity
Equities
Real Assets
Real Assets Chart 25.4% Natural Resources 22.2% MLPs 18.8% REITs 1.5% Inflation
Real Assets

See performance for additional asset classes

Source: Calculated by PGIM Investments using data presented in Morningstar software products. All rights reserved. Used with permission. As of 12/31/2017. Average returns represent the simple average of returns for the most recent six rising rate periods: 10/1/01–3/31/02, 5/1/03–6/30/06, 12/1/08–12/31/09, 8/1/10–3/31/11, 7/1/12–12/31/13, 7/1/16–1/31/17. Rising rate periods are defined as a period when the 10-year U.S. Treasury yield rose by 75 basis points or more, and ends when the yield declines by 5% of its peak value. Returns for periods longer than one year have been annualized. 75 basis points increase in the 10-Year Treasury represents a substantial increase in interest rates. Past performance is no guarantee of future results.

Portfolio Construction Impact of Rising Rates on Portfolios

Adjust Fixed Income Allocation

On average during the last six rising rate periods, reallocating 5% from a traditional U.S. bond allocation to less interest-rate-sensitive fixed income sectors would have resulted in higher returns at relatively similar levels of risk.

Portfolio C Add short duration high yield bonds (SDHY)

Add short duration high yield bonds (SDHY)

  • 60% U.S. Equity
  • 35% U.S. Bonds
  • 5% SDHY
Portfolio B Add floating rate loans

Add floating rate loans

  • 60% U.S. Equity
  • 35% U.S. Bonds
  • 5% Floating Rate Loans
Portfolio A Add non-traditional bonds

Add non-traditional bonds

  • 60% U.S. Equity
  • 35% U.S. Bonds
  • 5% Non-traditional Bonds
Portfolio 60/40 60/40 Portfolio - Traditional Portfolio

60/40 Portfolio - Traditional Portfolio

  • 60% U.S. Equity
  • 40% U.S. Bonds

Source: Calculated by PGIM Investments using data presented in Morningstar software products. All rights reserved. Used with permission. As of 12/31/2017. Average data represent the simple average of data for the most recent six rising rate periods: 10/1/01–3/31/02, 5/1/03–6/30/06, 12/1/08–12/31/09, 8/1/10–3/31/11, 7/1/12–12/31/13, 7/1/16–1/31/17. Rising rate periods are defined as a period when the 10-year U.S. Treasury yield rose by 75 basis points or more, and ends when the yield declines by 5% of its peak value. Returns for periods less than one year have not been annualized. Graph is hypothetical in nature and used for illustrative purposes only. Past performance is no guarantee of future results. See index definitions

Portfolio Average Return (%) Average Risk (%) Average Sharpe Ratio
60/40 11.19 7.28 1.91
A 11.44 7.33 1.94
B 11.68 7.30 1.98
C 11.98 7.40 2.02
Expand Equity Allocation

On average during the last six rising rate periods, reallocating 10% from a traditional U.S. equity allocation to global/international equities would have resulted in better returns with relatively similar risk, while reallocating 10% from traditional U.S. equities (typically large caps) to small cap equities would have resulted in enhanced risk-adjusted returns.

Return (%)
12.25
12.00 11.75 11.50 11.25 11.00
Portfolio F Portfolio E Portfolio D Traditional Expand Equity Allocation Portfolio F Portfolio E Portfolio D Traditional
F Add small cap equities

Add small cap equities

  • 50% U.S. Equity
  • 40% U.S. Bonds
  • 10% Small Cap Equities
E Add international equities

Add international equities

  • 50% U.S. Equity
  • 40% U.S. Bonds
  • 10% International Equities
D Add global equities

Add global equities

  • 50% U.S. Equity
  • 40% U.S. Bonds
  • 10% Global Equities
60/40 60/40 Portfolio - Traditional Portfolio

60/40 Portfolio - Traditional Portfolio

  • 60% U.S. Equity
  • 40% U.S. Bonds

Source: Calculated by PGIM Investments using data presented in Morningstar software products. All rights reserved. Used with permission. As of 12/31/2017. Average data represent the simple average of data for the most recent six rising rate periods: 10/1/01–3/31/02, 5/1/03–6/30/06, 12/1/08–12/31/09, 8/1/10–3/31/11, 7/1/12–12/31/13, 7/1/16–1/31/17. Rising rate periods are defined as a period when the 10-year U.S. Treasury yield rose by 75 basis points or more, and ends when the yield declines by 5% of its peak value. Returns for periods less than one year have not been annualized. Graph is hypothetical in nature and used for illustrative purposes only. Past performance is no guarantee of future results. See index definitions

Portfolio Average Return (%) Average Risk (%) Average Sharpe Ratio
60/40 11.19 7.28 1.91
D 11.36 7.24 1.92
E 11.55 7.25 1.96
F 12.06 7.51 2.04
Include Real Assets Allocation

On average during the last six rising rate periods, reducing 10% from both traditional U.S. equity and U.S. bond allocations to add 10% exposure to real assets would have provided stronger absolute returns versus a traditional 60/40 portfolio.

Return (%)
13.00
12.60 12.20 11.80 11.40 11.00
Portfolio I Portfolio H Portfolio G Traditional Include Real Asset Allocation Portfolio I Portfolio H Portfolio G Traditional
I Add natural resources

Add natural resources

  • 54% U.S. Equity
  • 36% U.S. Bonds
  • 10% Natural Resources
H Add MLPs

Add MLPs

  • 54% U.S. Equity
  • 36% U.S. Bonds
  • 10% MLPs
G Add real estate

Add real estate

  • 54% U.S. Equity
  • 36% U.S. Bonds
  • 10% Real Estate
60/40 60/40 Portfolio - Traditional Portfolio

60/40 Portfolio - Traditional Portfolio

  • 60% U.S. Equity
  • 40% U.S. Bonds

Source: Calculated by PGIM Investments using data presented in Morningstar software products. All rights reserved. Used with permission. As of 12/31/2017. Average data represent the simple average of data for the most recent six rising rate periods: 10/1/01–3/31/02, 5/1/03–6/30/06, 12/1/08–12/31/09, 8/1/10–3/31/11, 7/1/12–12/31/13, 7/1/16–1/31/17. Rising rate periods are defined as a period when the 10-year U.S. Treasury yield rose by 75 basis points or more, and ends when the yield declines by 5% of its peak value. Returns for periods less than one year have not been annualized. Graph is hypothetical in nature and used for illustrative purposes only. Past performance is no guarantee of future results. See index definitions

Portfolio Average Return (%) Average Risk (%) Average Sharpe Ratio
60/40 11.19 7.28 1.91
G 11.90 7.77 1.91
H 12.38 7.35 2.01
I 12.61 7.76 2.07
Diversify Your Portfolio

On average during the last six rising rate periods, having a diversified portfolio of fixed income, equity and real assets would have generated higher risk-adjusted returns than a traditional 60/40 portfolio.

Return (%)
15.00
14.00 13.00 12.00 11.00 10.00
Portfolio J Traditional Diversify Your Portfolio Portfolio J Traditional
J Diversified Portfolio

Diversified Portfolio

  • 50% Equities 30% U.S. Equity 15% Small Cap Equity 5% Int’l Equities
  • 40% Bonds 25% U.S. Bonds 7.5% SDHY 7.5% Floating Rate Loans
  • 10% Real Assets 3.75% Natural Resources 3.75% MLPs 2.5% REITs
60/40 60/40 Portfolio - Traditional Portfolio

60/40 Portfolio - Traditional Portfolio

  • 60% U.S. Equity
  • 40% U.S. Bonds

Source: Calculated by PGIM Investments using data presented in Morningstar software products. All rights reserved. Used with permission. As of 12/31/2017. Average data represent the simple average of data for the most recent six rising rate periods: 10/1/01–3/31/02, 5/1/03–6/30/06, 12/1/08–12/31/09, 8/1/10–3/31/11, 7/1/12–12/31/13, 7/1/16–1/31/17. Rising rate periods are defined as a period when the 10-year U.S. Treasury yield rose by 75 basis points or more, and ends when the yield declines by 5% of its peak value. Returns for periods less than one year have not been annualized. Graph is hypothetical in nature and used for illustrative purposes only. Past performance is no guarantee of future results. See index definitions

Portfolio Average Return (%) Average Risk (%) Average Sharpe Ratio
60/40 11.19 7.28 1.91
J 15.08 7.92 2.40

Explore Strategies Planning for Rising Rates

Explore strategies that may help optimize investment portfolios during rising rate periods and learn more about our funds.

Fixed Income Strategies

Manage duration

Floating rate loans generally have lower sensitivity to interest rate movements than other fixed income securities because interest rates on loans typically reset quarterly, based on 3-month LIBOR, which generally moves in a similar direction as the federal funds rate.


PGIM Floating Rate Income Fund

A style-pure loan fund with a strong performance history, an attractive yield, and a higher credit quality bias.

Seek higher yield

Yields from high yield bonds are generally higher than other yield-oriented investments. Shorter duration, higher-rated high yield bonds may provide the potential for higher income while mitigating both interest rate and credit risk.


PGIM Short Duration High Yield Income Fund

A shorter duration high yield bond fund with competitive yield that has produced stronger risk-adjusted returns than its peers, through its higher rated, lower duration approach.

Seek to neutralize interest rate risk

A duration-neutral, multi-sector approach can help mitigate interest rate risk. A well-diversified, duration-constrained, absolute return strategy can uncover alpha-generating opportunities while avoiding systematic exposure to rising rates.


PGIM Absolute Return Bond Fund

A diversified multi-sector bond fund that limits duration to a band of +/-3 years.

Equity Strategies

Expand the opportunity set

The current U.S. equity bull market has led to stretched U.S. valuations in many areas, while global economies in earlier phases of their growth cycles offer more attractive valuations. Expanding portfolios to include international equity exposure can better capitalize on compelling growth opportunities.


PGIM Jennison Global Opportunities Fund

A highly active global growth fund with the flexibility to identify and act on compelling opportunities across the globe while avoiding regions and sectors with limited prospects.

 

PGIM Jennison International Opportunities Fund

A unconstrained growth fund focused on finding the best equity opportunities outside of the U.S., which may be suitable for investors seeking to complement an existing U.S. equity allocation.

Seek larger growth potential

Rates typically rise in response to better economic conditions. This has historically provided a positive backdrop for small cap companies and strong returns in rising rate environments.


PGIM Jennison Small Company Fund

A small cap growth fund that seeks to invest in small companies that may be underpriced by the market and have above-average growth prospects.

Real Assets Strategies

Capitalize on rising demand

Most global economies are synchronized in growth mode and growing economies typically experience increased demand for raw materials, which would likely benefit producers/providers of natural resources.


PGIM Jennison Natural Resources Fund

A flexible natural resources fund that combines top-down commodity analysis with bottom-up fundamental research to uncover attractive investment opportunities in companies that own, explore, mine, process, and develop natural resource commodities.

Immunize against rising rates and inflation

MLPs typically use long-term fixed rate loans and contracts with inflation-adjustors, so are more insulated against the adverse effects rising rates and inflation can have on asset prices.


PGIM Jennison MLP Fund

A total-return focused MLP fund that seeks to invest in high quality midstream and MLP companies that finance operations that gather, store and transport energy.

Hedge against inflation

Stronger economies typically result in rising demand for commercial real estate space. This includes valuations for land and buildings and higher rents for new leases, while inflation escalators in lease agreements help mitigate inflation.


PGIM Global Real Estate Fund

A global real estate fund that seeks to capitalize on potential real estate opportunities anywhere in the world.