Fighting Interest Rates with Bond Ladders

by on Jun 22, 2017

Citing moderate economic growth, solid labor statistics and increased inflation, the Federal Reserve increased interest rates by 25 basis points last quarter. In an effort to normalize policy after nearly a decade of historically low rates, the Fed is expected to continue to raise rates. As a result, investors are worried about the potential for rising rates to impact bond returns negatively by causing prices to fall. Those looking to position their portfolios to withstand higher rates in the future and gain a steady stream of income are encouraged to try municipal bond ladders, as a new dynamic tool from Lord Abbett attempts to illustrate.

Laddering a municipal bond strategy involves building a portfolio of bonds with staggered maturities so that as shorter bonds roll out of the lower-ladder range, proceeds are invested in the higher-yield upper-ladder range, which can yield positive income and total returns in rapidly rising rate environments. The laddered approach has three perceived benefits. First, ladders can mitigate price risk because they hold bonds to maturity. Second, the investor receives a coupon from each bond either to reinvest or to take as income. Finally, since investors buy a new bond at the longest maturity of the ladder, the new bond will have a higher yield based on the current interest rates in the market.

Muni Ladder

Lord Abbett’s recently introduced Muni-Ladder Interest Rate Scenario Tool allows users to enter assumptions for investment amount, ladder range, state, taxable income, tax filing status and customized interest rate increase and duration. Two charts dynamically adjust to reflect estimated income and estimated return. The first illustrates the estimated annual and cumulative income, while the second highlights the estimated return in percentages and dollars. The information is presented in both chart and table formats. Figures at the bottom provide a tax summary, tax-free yield and tax-equivalent yields at inception.

Lord Abbett Muni-Ladder Interest Rate Scenario Tool (Top)

The tool makes use of several elements to provide users additional guidance. A video tutorial provides a brief explanation of laddered portfolios, followed by step-by-step instructions on how to use the tool. A flyer includes a municipal ladder illustration and discusses the advantages of professional management. Balloon tip definitions and hover-over callouts throughout provide additional context for tax terms. While the tool is easy to use and interactive, it does not take credit ratings into account or consider the importance of high-quality bonds. Lord Abbett could go further in detailing the specifics of how laddered investing works and in supplying users with guidance on how to build a bond ladder and how to apply the tool to their own portfolios.

Lord Abbett Muni-Ladder Interest Rate Scenario Tool (Continued)