Real Interest Rate Shocks and Portfolio Strategy

Shocks to interest rates are important to analyze because they change asset and liability values in somewhat predictable ways. In other words, portfolios can be prepared in advance, to absorb those shocks.

Interest rates affect almost every aspect of economic activity. They not only mechanically impact the prices of fixed income securities, but also influence the market values of stocks, alternative assets, and long-term liabilities such as those of pension funds. Shocks to interest rates, unexpected changes in the rate, are important to analyze because they change asset and liability values in somewhat predictable ways, depending on the asset class under consideration and the reasons for the shock. In other words, portfolios can be prepared, in advance, to absorb those shocks.

In previous work, we examined the potential effects of shocks to economic growth on portfolio performance and suggested how to position portfolios to defend against such shocks. In this article, and in a forthcoming companion piece, we do the same for interest rates and inflation, which are inextricably linked. This topic is too large to cover in a compact paper, so we split the topic in two as follows:

  • The current piece focuses on real (inflation-adjusted) interest rates and their influence on fixed income assets and on liabilities, although we cover other asset classes as well.
  • The companion piece will focus on inflation and examine the way that it feeds through to all assets in a multi-asset portfolio, as well as through to liabilities.

Read the full article here.

Shocks to Macroeconomic Factors

Contributors

  • Head of Client Investment Solutions, Franklin Templeton Multi-Asset Class Solutions
  • Head of Multi-Asset Research Strategies, Franklin Templeton Multi-Asset Class Solutions
  • Director of Research, CFA Institute Research Foundation