Merrill Lynch: Bonds Still Matter in Rising Interest Rate Environment

June 19, 2018 — 2:14 PM EDT

With the Federal Reserve raising interest rates, bond investors may be heading for the hills, but Merrill Lynch Wealth Management head of fixed income strategy Matthew Diczok said that bonds always play an important role in a diversified portfolio.

Diczok said in a video post that, while rising interest rates can lower the price of existing bonds and affect the current value of bond holdings, that doesn't make bonds less "essential" for a well-diversified portfolio, particularly when volatility is back in the markets. Investors can't predict the future, including where interest rates are heading, and as a result, they need to have bond exposure in their portfolios. After all, bonds can provide a cushion for the unexpected and ensure that investors are broadly diversified, he said. "Bonds are critical in helping balance your risk," noted Diczok.

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According to the fixed income strategist, investors who have money in a bond mutual fund will not only receive regular interest payments for as long as they own the shares, but because lots of bond funds are actively managed, investors could see interest payments increase when interest rates are rising as the fund manager reinvests the coupon and principal payments into new bonds that have higher yields. Keep in mind that, unlike individual bonds, there is no maturity date for bond funds, which means that when you sell the shares matters.

Diczok said that investors considering an investment in an individual bond should focus less on the bond's price and more on the yield they will get. Investors should also be willing to own the bond until maturity to ensure they receive the regular coupon payments as well as the full principal back.

Merrill Lynch's Diczok isn't the only strategist that has been making the case for bonds even as the Federal Reserve raises interest rates. Last month, Jeff Moore, a fund manager at Fidelity Investments, argued in an interview with Bloomberg that the bond sell-off in the U.S. and Canada has raised yields on bonds that come due within 10 years to levels that will give investors a decent return. "I'm actually more excited going forward than I was in the last five years," Moore told Bloomberg. "You may have a period where rising rates affect the prices, but over the course of one, two and three years these higher yields mean that investors can increase their bond market expectations."

Moore co-manages around $50 billion in fixed income for Fidelity, focusing on the U.S and Canada markets. The way Moore sees it, the three interest rate hikes expected from the Federal Reserve this year are already baked into prices, as are two more rate hikes by the Bank of Canada. For yields to move up more and hurt the value of bonds, Moore said that central banks in both countries would have to move at a quicker pace, which he doesn't think will happen.