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.

Period 1

Oct 2001 - Mar 2002

Change in 10-year Treasury

+115 bps

Fed Funds Rate

Decreasing

Average GDP

1.6%

Average Inflation

2.3%

Period 2

May 2003 - Jun 2006

Change in 10-year Treasury

+179 bps

Fed Funds Rate

Increasing

Average GDP

3.4%

Average Inflation

2.2%

Period 3

Dec 2008 - Dec 2009

Change in 10-year Treasury

+160 bps

Fed Funds Rate

Steady

Average GDP

-1.9%

Average Inflation

1.9%

Period 4

Aug 2010 - Mar 2011

Change in 10-year Treasury

+97 bps

Fed Funds Rate

Steady

Average GDP

2.1%

Average Inflation

1.0%

Period 5

Jul 2012 - Dec 2013

Change in 10-year Treasury

+154 bps

Fed Funds Rate

Steady

Average GDP

1.7%

Average Inflation

1.6%

Period 6

Jul 2016 - Jan 2017

Change in 10-year Treasury

+100 bps

Fed Funds Rate

Increasing

Average GDP

2.3%

Average Inflation

1.6%

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.

17.7% 11.0% 6.3% 1.6% Short Duration High Yield Floating Rate Loan Non-traditional Bond U.S. Bond
Short Duration High Yield

Short duration, higher-rated high yield bonds offer low-to-negative correlation to interest-rate-sensitive bonds.

Floating Rate Loan

Interest rates on floating rate (bank) loans typically reset quarterly, based on 3-month LIBOR, which generally moves in a similar direction as the federal funds rate.

Non-traditional Bond

Non-traditional, absolute return bond strategies use duration management to help mitigate interest rate risk.

Fixed Income

Equities

Rising rates due to a stronger economy can be a boon for equities. Economic optimism has been particularly beneficial for small cap and international equities, which have outperformed the broader U.S. equity market during rising rate periods.

26.6% 21.7% 19.6% 17.7% Small Cap Equity Int’l Equity Global Equity U.S. Equity
Small Cap Equity

Smaller companies rely more on domestic sales, and are less prone than larger export-oriented companies to strong-dollar price pressures (typically a side effect of higher rates).

International Equity

Rising rates typically reduce P/E valuations, so countries with lower rates can provide better valuations versus the U.S.

Global Equity

Global economic cycles and conditions vary, which allows global equity strategies to better capitalize on the strongest equity opportunities wherever they may be in the world.

Equities

Real Assets

Real assets typically retain their value during inflationary periods—which usually coincide with rising rates. MLPs and real estate tend to benefit from increased demand during stronger economies in rising rate periods.

25.4% 22.2% 18.8% 1.5% Natural Resources MLPs REITs Inflation
Natural Resources

Unlike direct commodity exposure, which tends to be pressured in a rising rate environment, indirect commodity exposure via companies that produce/provide natural resources has performed well due to increased demand for raw materials.

MLPs

MLPs primarily use long-term fixed debt to finance growth projects, so are generally more insulated against rising costs from higher interest rates. Additionally, pipeline contracts have built-in inflation-adjustors which can neutralize effects from rising inflation.

REITs

Rising rates usually coincide with rising inflation. Leases often have provisions to increase rents if inflation rises, which has helped income from REITs outpace 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.

Return (%)
12.00
11.80 11.60 11.40 11.20 11.00
Portfolio C Portfolio B Portfolio A Traditional Portfolio C Portfolio B Portfolio A Traditional
C

Add short duration high yield bonds (SDHY)

  • 60% U.S. Equity
  • 35% U.S. Bonds
  • 5% SDHY
B

Add floating rate loans

  • 60% U.S. Equity
  • 35% U.S. Bonds
  • 5% Floating Rate Loans
A

Add non-traditional bonds

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

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 Risk and Return Details

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 Portfolio F Portfolio E Portfolio D Traditional
F

Add small cap equities

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

Add international equities

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

Add global equities

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

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 Risk and Return Details

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 Portfolio I Portfolio H Portfolio G Traditional
I

Add natural resources

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

Add MLPs

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

Add real estate

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

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 Risk and Return Details

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 Portfolio J Traditional
J

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% 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 Risk and Return Details

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 Stratagies

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.

Browse List of Funds