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Real Interest Rate Shocks and Portfolio Strategy

Eugene Podkaminer, Wylie Tollette and Laurence Siegel
The Journal of Investing October 2020, 29 (6) 23-41; DOI: https://doi.org/10.3905/joi.2020.1.148
Eugene Podkaminer
is the head of multi-asset research strategies within the Multi-Asset Solutions group at Franklin Templeton Investments in San Mateo, CA
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Wylie Tollette
is the head of client investment solutions within the Multi-Asset Solutions Group at Franklin Templeton Investments in San Mateo, CA
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Laurence Siegel
is the Gary P. Brinson director of research for the CFA Institute Research Foundation in Charlottesville, VA
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Abstract

Fluctuations in real interest rates affect every aspect of an investment program, including the present value of the liability, as well as the returns on each asset class. We review the history and causes of real interest rate fluctuations using a nonmathematical very simple macro model, then assess the risks to each major asset class (and also to liabilities) from likely changes in the real rate. The objective is to help investors defend their portfolios against this important risk. An appendix provides deep history, showing that real interest rates have declined over very long periods of time as markets and political institutions have become more developed.

TOPICS: Real estate, commodities, real assets/alternative investments/private equity, currency, private equity

Key Findings

  • • Rapidly rising real rates pose a substantial risk to the whole portfolio, through both fixed income and equity assets. Although the risk posed to fixed income is direct and mechanical, the risk posed to equities and alternative assets is complex and subtle.

  • • This asset-side risk may be offset, to a greater or lesser degree, depending on the real interest rate duration of the liability, by a decrease in liability valuation due to rising real rates (again, depending on duration).

  • • The risk of a decline in real interest rates comes from the opportunity-cost of being out of a rising bond fixmarket. Many investors, leery of the potential for rising rates, have shortened the duration of their holdings and would not participate to a satisfactory extent if a bond rally were to occur due to rates falling further.

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The Journal of Investing: 29 (6)
The Journal of Investing
Vol. 29, Issue 6
October 2020
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Real Interest Rate Shocks and Portfolio Strategy
Eugene Podkaminer, Wylie Tollette, Laurence Siegel
The Journal of Investing Sep 2020, 29 (6) 23-41; DOI: 10.3905/joi.2020.1.148

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Real Interest Rate Shocks and Portfolio Strategy
Eugene Podkaminer, Wylie Tollette, Laurence Siegel
The Journal of Investing Sep 2020, 29 (6) 23-41; DOI: 10.3905/joi.2020.1.148
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  • Article
    • Abstract
    • NOMINAL AND REAL INTEREST RATES
    • THE CENTRAL ROLE OF LIABILITIES
    • PRINCIPAL FINDINGS
    • REAL INTEREST RATE SHOCKS AND THE MULTI-ASSET PORTFOLIO
    • BONDS HAVE TWO DURATIONS
    • THE VSMM
    • EXPLAINING REAL INTEREST RATES WITH THE VERY SIMPLE MACRO MODEL
    • LOOKING TOWARD THE FUTURE
    • REAL INTEREST RATE DURATION AND PORTFOLIO MANAGEMENT
    • IMPLICATIONS FOR FIXED-INCOME PORTFOLIOS AND FOR ASSET-LIABILITY MANAGEMENT
    • IMPLICATIONS FOR OTHER ASSET CLASSES
    • INTERNATIONAL ISSUES
    • CONCLUSION: CONSIDERATIONS FOR INVESTORS
    • ADDITIONAL READING
    • ACKNOWLEDGMENTS
    • APPENDIX
    • ENDNOTES
    • REFERENCES
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