- Bond yields can rise due to several factors including rise in inflation expectations.
- Generally, when yields tend to surge, investors start shifting their investment to debt from equities.
- The cost of capital for companies also rises with a rise in bond yields.
The rise in bond yields is driven by a variety of factors including monetary policy of the central bank, government’s fiscal position, global markets, economy, and inflation. Surging bond yields come as a scare for investors, who then look for ways to safeguard their investment portfolio. Generally, when yields tend to surge, investors start shifting their investments to debt from equities.
The cost of capital for companies also goes up with a rise in bond yields. It leads to a decline in the valuation of the stocks of the companies. A cut in repo rate brings down the cost of borrowings, resulting in the rise of share prices and vice versa.
What exactly is a bond yield?
Bond yield is the return an investor realises on a bond over a particular period, expressed as a percentage or interest rate. The mathematical formula for calculating yield is the annual coupon rate divided by the bond’s current market price. As the price of the bond rises, the yield falls. Similarly, with a fall in bond’s price, the yield soars.
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How can investors safeguard their portfolio amid rising bond yields? Here are four points to keep in mind:
Buy on the dip
Investors could focus on “buy on the dip” approach. The entry prices start to look more enticing as the long end of the yield curve deepens. Rising yields could potentially provide an interesting opportunity to investors to reload on equities.
Value investing is a theme to choose when the market is up against the challenges posed by rising bond yields. Investors can pick up value stocks at bargain to get a decent margin of safety during such times. The stocks with strong fundamentals and value should be picked up by investors as against growth stocks.
Overall, rising bond yields gradually lead to a rally in tech and other growth stocks as investors are concerned about erosion of long-cash flows or these companies.
However, higher yields have historically impacted cyclical stocks sectors such as financials and materials, which could benefit from higher growth rates, higher cash rates – or both. In addition, having a judicious mix of debt with equity provides stability to the portfolio return.
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The fixed income investors can look to invest in government securities when the bond yields are rising. They will not only get a regular cash flow, but government securities also offer a very safe investment option.
Gold can be another option
As the bond yields rise, the expectation of a stronger economy also holds ground. Since a robust economy leads to inflation, gold is used as a hedge against inflation, So, rising bond yields are positive for gold in the long term. But, in short term, investors increase allocation in bonds as against gold, which exerts pressure on the prices of the yellow metal.