Investment Committee Perspectives

PMC Tactical ETF Fixed Income Portfolio: Guarding portfolios against interest rate risks

While low interest rates helped fuel the domestic equity markets in 2013, investors this year face the threat of rising interest rates as the Federal Reserve plans to continue tapering its bond-buying program. As such, many are forecasting a rough year for bonds. Does this mean investors should steer clear of bonds in 2014? What kind of fixed income approach can investors rely on to help manage the risk in their portfolios?

The PMC Tactical ETF Fixed Income Portfolio can provide stability to returns and control risk, even in these persistent volatile markets. The dramatic changes in the bond markets and speculation around what the Fed will do next can provide a rough ride for investors to navigate with a traditional fixed income approach, given inherent increased interest rate risk. With the ability to dynamically adjust exposures and durations across a wide spectrum of fixed income sectors globally, this portfolio can serve as an investor’s core fixed income allocation in various economic environments, over both short- and long-term horizons.

Preparing for 2014 and beyond: maneuvers in the portfolio in 2013
Throughout 2013, the Tactical Fixed Income Portfolio’s sub-advisor, Innealta Capital, meaningfully reduced the duration and spread exposures of the portfolio in response to decreasing credit spread levels, and an increased likelihood of higher long-term interest rates relative to those in the shorter-term (Figure 1). Importantly, Innealta decreased portfolio duration by about 40%, which was achieved by reducing long-term exposures in favor of shorter-term and more liquid positions. These adjustments also prepared the portfolio for potential inflation pressures and the Fed’s unwinding of asset purchases, which both could add even more upward pressure to longer-term rates.

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Investments in smaller companies carry greater risk than is customarily associated with larger companies for various reasons such as volatility of earnings and prospects, higher failure rates, and limited markets, product lines or financial resources. Investing overseas involves special risks, including the volatility of currency exchange rates and, in some cases, limited geographic focus, political and economic instability, and relatively illiquid markets. Income (bond) funds are subject to interest rate risk which is the risk that debt securities in a fund’s portfolio will decline in value because of increases in market interest rates.

Exchange-Traded Funds (ETFs) are subject to risks similar to those of stocks, such as market risk. Investing in ETFs may bear indirect fees and expenses charged by ETFs in addition to its direct fees and expenses, as well as indirectly bearing the principal risks of those ETFs. ETFs may trade at a discount to their net asset value and are subject to the market fluctuations of their underlying investments. Income (bond) ETFs are subject to interest rate risk which is the risk that debt securities in a portfolio will decline in value because of increases in market interest rates.

The PMC Tactical Portfolio may utilize inverse and leveraged ETFs. Leveraged ETFs are ETFs that employ financial derivatives and debt to try to achieve a multiple (for example two or three times) of the return or inverse return of a stated index or benchmark over the course of a single day. Inverse ETFs utilize short selling, derivatives trading, and other leveraged investment techniques, such as futures trading to achieve their objectives, mainly to track the inverse of their benchmarks. Inverse and leveraged ETFs are generally most suitable for sophisticated investors who understand leverage and are willing to assume the risk of magnified potential losses. Given the risk/ return trade-offs, these types of ETFs may not be appropriate for long-term investors who typically subscribe to “buy and hold” investment strategies.

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