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Consider Correlation When Interest Rates Rise

04/10/2014

In our last blog, “All Fixed Income Sectors Are Not Created Equal,” we examined how interest rate changes impact various fixed income sectors differently, with shorter-term bonds offering the best long-term potential in a rising-rate environment. As a follow-up to that discussion, today we’ll consider the correlation of fixed income sectors to U.S. Treasuries and how certain sectors offer greater diversification potential within a bond portfolio.

Correlation, simply put, measures the similarity of returns of one investment to another. An investment with a correlation of +1 means that it has perfect positive correlation to another investment, or that as one investment moves up or down, the other investment moves in tandem. An investment with a -1 correlation means that it is perfectly negatively correlated, or that its returns move in the opposite direction.

The chart below shows the correlation of various fixed income sectors, as represented by their corresponding indexes, to the benchmark 10-year U.S. Treasury. With Treasury rates low, sectors with low or negative correlation—such as floating-rate bank loans, corporate high yield bonds, and commercial mortgage-backed securities—offer the opportunity for investors to diversify their traditional fixed income portfolios, help offset an increase in interest rates, and generate more income in a low yield environment.

10-YEAR CORRELATION, 4/1/04 – 3/31/14

Source: Morningstar Direct.

Past performance is not a guarantee of future results.

Virtus Investment Partners provides this communication as a matter of general information. The opinions stated herein are those of the author and not necessarily the opinions of Virtus, its affiliates or its subadvisers. Portfolio managers at Virtus make investment decisions in accordance with specific client guidelines and restrictions. As a result, client accounts may differ in strategy and composition from the information presented herein. Any facts and statistics quoted are from sources believed to be reliable, but they may be incomplete or condensed and we do not guarantee their accuracy. This communication is not an offer or solicitation to purchase or sell any security, and it is not a research report. Individuals should consult with a qualified financial professional before making any investment decisions.