7. Emerging market debt correlates more closely to U.S. government debt than high yield. But its moves are sharper. Downturns are more vicious and its recoveries more rewarding. After notable recent weakness, investment managers say the sector could soon offer attractive yields with relatively safe credit quality.
8. Floating rate bank loan funds are reset on 30-, 60- and 90-day intervals, much like variable rate home mortgages, and follow short-term rates dictated by the Federal Reserve. The rates are lower than average now because investors have flooded into the market for their protection against rising rates. It may be early to buy floating rates, but when the Fed lets short-term rates rise, their yields will float higher.
Still, the floating rate sector illustrates a key point for investors to keep in mind. As interest rates rise, so does credit risk. Many of the issuers of the senior loans have low investment ratings. When today's ultra-low rates go away, marginal companies that have been getting by with the help of low rates could be pushed to the brink.
"There are a lot of moving parts in credit and interest rates now," says Aaron Izenstark, co-founder and chief investment officer of Iron Financial, an investment management and risk-based advisory firm. "In long-term, there will be significant changes. When the Fed removes $1 trillion a year from securities purchase that is a big adjustment."
Investors need to consider not only their direct holdings but holdings of funds they own. Target-date funds, for example, are invested in a broad range of assets and may hold large amounts of fixed income, some of which is matched to the funds' specified retirement dates. Many income funds also take credit risks to boost yield, Izenstark says. Many hold non-government mortgages securities, a sector that he sees as vulnerable to credit risk. He says it could be worthwhile to review the prospectuses for your funds to see what kinds income investing risks they are taking. Funds are required to list such vulnerabilities.
Given the outlook for rising rates and the debt market's broad exposure to risks, now is no time for long-term bond investing, investment managers say. For long-term positions, equities make more sense, especially those that pay dividends from strong cash flow. "I see more headwinds on horizon in fixed income," says Bryn Mawr's Cecilia. "I would be very cautious. This transition to higher interest rates could bring a lot of volatility that may continue for a while. It could be very messy. Equities are more favorable."