JFD-WEALTH_WHITE-PAPER-SERIES_1

WHITE PAPER
INVESTMENT PORTFOLIO BEHAVIOUR
IN A RISING INTEREST RATE ENVIRONMENT

2
INVESTMENT PORTFOLIO BEHAVIOUR IN A RISING INTEREST RATE ENVIRONMENT
UNDERSTAND THE PAST TO PREPARE FOR THE FUTURE
EXECUTIVE SUMMARY
As major developed economies have been oper-
ating for such a long time in an environment of
historically low interest rates and could enter a
phase of interest rate rises towards the end of
the year, investors should consider adjusting the
mix of their investments in order to protect and
enhance their portfolio performance.
In an effort to examine the behaviour of invest-
ment portfolios with regards to performance
and risk measurements, as well as derive a range
of effective strategies for addressing the poten-
tial risks associated with an interest rate rise, we
have conducted a case study of the impact of the
U.S. Fed’s interest rate rising actions during the
period of 1982 – 2015.
While past performance does not guarantee fu-
ture results, studying previous rate hike periods
can provide us with a valuable insight towards
managing investment portfolios entering a rising
rate environment. Our findings show that both
equities and bonds have appeared to record a
better performance during periods of slow-paced
interest rates rises, while in the opposite case, the
behaviour of various asset categories appears to
be more complex.
While there is no simple answer regarding the
manner in which rising interest rates affect var-
ious asset classes because of the complexity of
factors involved (severity and magnitude of the
increase, frequency and time length of incremen-
talrises,stateoftheeconomy),wehavepresented
a range of strategies for protecting and enhancing
investment portfolios as we approach the start of
a series of interest rate rises in major global econ-
omies such as the U.S. and the U.K. In perspective,
however, asset allocation adjustments must al-
ways be tailored around the individual investor’s
specific requirements as well as risk tolerance.

3
JFD WEALTH AT A GLANCE
Presence:
Flagship:
Annualized Performance:
MAR Ratio:
60 countries
Top Spin
25.75%
2.74
www.jfdbrokers.com
www.jfdprime.com
www.jfdwealth.com
research.jfdbrokers.com
As of Q2, 2015
JFD Brokers:
JFD Prime:
JFD Wealth:
JFD Research:
KEYFACTS
JFD GROUP
WWW.JFDCHANGE.COM

4
PART I
CASE STUDY: FED DURING 1982-2015 PERIOD
Context
Definition of Fed Funds Rates
Interest Rates Hiking Process
Today’s Picture
Past Interest Rate Cycles Analysis
Performance of Equities During Previous Interest Rate Rising Cycles
Performance of Fixed Income Securities During Previous Interest Rate Rising Cycles
PART II
ANALYSIS: SHIELDING AND ENHANCING INVESTMENT PORTFOLIOS
Shielding and Enhancing Investment Portfolios in a Rising Interest Rate Environment
Investment Alternatives in Equities
Rebalancing the Fixed Income Securities Mix
Adjusting the Asset Allocation of the Portfolio
Housing Sector and Debt Refinancing
Hedging Against Inflation
The Impact on the Currency and the Importance of Currency Diversification
CONCLUSION
TABLE OF CONTENTS

5

6
PART I
CASE STUDY: IMPACT OF FED
ACTION DURING 1982-2015 PERIOD
In the context of policy interest rates at all-time lows for the major developed economies, investors are
sooner or later bound to face a rising interest rate environment, which could be very challenging for
managing portfolios. In this paper we present our observations and insights based on a case study that
we have performed on the behaviour of investment portfolios with regards to performance and risk
measurements during past periods of rising interest rates.
As central banks’ strategies differ from one country to another, for the sake of argument we have
chosen the Federal Reserve (Fed) Funds rates as an indicator of a rising/falling interest rate environ-
ment.
While past performance does not guarantee future results, studying previous rate hike periods can
provide us with a valuable perspective towards managing investment portfolios within a rising rate
environment.
EXECUTIVE SUMMARY

7
DEFINITION OF
FED FUNDS RATES
AND INFLATION
Fed Funds are overnight loans which banks use
in order to meet the requirements at the end of
each day. The required amount is set by the Fed
and it varies according to the size of each bank.
Inflation represents an increase in the overall
price level of goods and services in an economy
over a certain time period. Fed policy makers
evaluatechangesininflationbyexaminingseveral
different price indices which measure price
changes of various sectors of goods and services.
As inflation numbers can vary significantly from
month to month, policy makers generally focus
on average inflation over longer time intervals,
ranging from a few months to a year or even
longer.
The Federal Open Market Committee believes
that an inflation rate close but below the 2.00
percent (yoy) level is healthy for the economy.
However, history shows that the Fed Funds rate
might have been well above this level in order
to curb runaway inflation, or below it in order to
stimulate economic growth.

8
The Fed increases interest rates by raising the target for the Fed Funds rate. Technically speaking, rates
are set by the banks themselves rather than by the Fed. However these rates rarely vary from the tar-
get rate, as in that case the Fed would use various tools such as discount window, discount rate and re-
serve balance supply to name a few, in order to create enough pressure on the banks to meet its target.
Central banks begin to raise rates when they are confident that the economy is safely out of recession,
or when the economy overheats and inflation is on the rise.
The 10-year U.S. Treasury yield hit an all-time low of 1.40 percent on June 2012 and has since then
gradually been moving higher. Furthermore, the current Fed Funds rate is at its all-time low of 0.00 -
0.25 percent range since December 16, 2008.
The current era of low interest rates is a consequence of the unprecedented actions of the Fed and
other central banks taken in their effort to handle the global financial crisis. The Fed initially employed
traditional monetary policy tools, lowering the Fed Funds target rate from 5.25 percent in September
2007 to a 0.00 - 0.25 percent range by December 2008, where it has since remained. In November
2008, amid near-frozen credit markets, with overnight rates being close to zero and the U.S. economy
experiencing the worst recession since the 1930s, the Fed embarked on a Quantitative Easing (QE)
program.
INTEREST RATES HIKING PROCESS
TODAY’S PICTURE
Source : JFD Wealth, research.stlouisfed.org
GRAPH I: HISTORICAL 10-YEAR U.S TREASURY YIELD (WEEKLY BASIS)
18
16
14
12
10
8
6
4
2
0
Yield (%) Historical Average (6.44%) Table as of 31 July 2015
1962-01-05
1964-01-05
1966-01-05
1968-01-05
1970-01-05
1972-01-05
1974-01-05
1976-01-05
1978-01-05
1980-01-05
1982-01-05
1984-01-05
1986-01-05
1988-01-05
1990-01-05
1992-01-05
1994-01-05
1996-01-05
1998-01-05
2000-01-05
2002-01-05
2004-01-05
2006-01-05
2008-01-05
2010-01-05
2012-01-05
2014-01-05

9
One of the most popular market indicators of interest rates for many investors is the Fed’s monetary
policy position, therefore the Fed Funds rate is a decisional tool in implementing such policy decisions.
To simplify our analysis, we define a rising rate period as a timeframe when the Fed is tightening its
policy.
As previously mentioned, Fed Fund rates are raised in order to temper inflation even if has not yet
materialised. The Fed’s decision is also influenced by labour markets and economic growth factors.
From 1982 to date, we have identified 5 periods of rising interest rates, as listed in TABLE I.
Historical analysis is an objective way of understanding how different asset classes typically respond
to periods of rising rates. In our analysis we examine the performance behavior of the two major asset
classes in standard portfolios, namely equities and bonds.
PAST INTEREST RATE CYCLES ANALYSIS
Source : Research.Stlouisfed, JFD Brokers
GRAPH II: FEDERAL FUNDS TARGET RATE
TABLE I: RISING RATE PERIODS
Table as of 31 July 2015, Benchmark: Federal Funds Target Rate
10
8
6
4
2
0
Yield (%) Period Table as of 31 July 2015
1982-09-27
1983-09-27
1984-09-27
1985-09-27
1986-09-27
1987-09-27
1988-09-27
1989-09-27
1990-09-27
1991-09-27
1992-09-27
1993-09-27
1994-09-27
1995-09-27
1996-09-27
1997-09-27
1998-09-27
1999-09-27
2000-09-27
2001-09-27
2002-09-27
2003-09-27
2004-09-27
2005-09-27
2006-09-27
2007-09-27
2008-09-27
2009-09-27
2010-09-27
2011-09-27
2012-09-27
2013-09-27
2014-09-27
II III IV VI
PERIOD NUMBER
BEGIN DATE
END DATE
LENGTH (YEARS)
BEGIN RATE (%)
END RATE (%)
ITERATIONS
YIELD CHANGE (%)
I
31.03.1983
09.08.1984
1,36
8,50%
11,50%
12
3,00%
II
29.03.1988
17.05.1989
1,13
6,5%
9,8125%
16
3,3125%
III
04.02.1994
01.02.1995
0,99
3,00%
6,00%
7
3,00%
IV
30.06.1999
16.05.2000
0,88
4,75%
6,5%
6
1,75%
V
30.06.2004
29.06.2006
2,00
1,00%
5,25%
17
4,25%

10
Market participants believe that rising rates are bad for stocks, in other words if interest rates rise and
therefore the discount rate moves higher, stock prices should theoretically go down. When interest
rates are high and investors are offered “risk-free” yields for their hard-earned cash, they would be
inclined to park their money in the bank rather than take any chances with stocks, which have no guar-
antee on their returns or even on receiving their initial capital invested. The opposite belief holds in the
case of low interest rates.
HoweverthisdoesnotnecessarilyholdtrueaccordingtothefindingsofTABLEII,whichshowstheS&P
500 Index performance following the five previous periods of rising interest rates, as already defined in
TABLE I. In fact, if rates are moving higher as a result of the Fed’s belief that the economy is improving,
the influence of stock prices will be a positive one.
Furthermore, TABLES III (A) and (B) indicate that different interest rate rising periods lead to equity
performance disparities. The velocity of interest rate change within a specific period, is defined by
granularity, which is the ratio of percentage yield change over the number of iterations during the
period (Granularity = Yield Change / Iterations).
PERFORMANCEOFEQUITIES
DURINGPREVIOUSINTERESTRATE
RISINGCYCLES
TABLE II: PERFORMANCE OF S&P 500 INDEX DURING PAST RISING RATE PERIODS
Table as of 31 July 2015, Benchmark: Federal Funds Target Rate & S&P 500 Index
PERIOD NUMBER
BEGIN DATE
END DATE
LENGTH (YEARS)
PERFORMANCE OVER PERIOD
ANNUALISED PERFORMANCE
MAX. DRAWDOWN
VOLATILITY
I
31.03.1983
09.08.1984
1,36
7,91%
5,75%
-14,38%
12,79%
II
29.03.1988
17.05.1989
1,13
28,8%
25,0%
33,5%
4,00%
III
04.02.1994
01.02.1995
0,99
2,14%
2,16%
8,69%
9,54%
IV
30.06.1999
16.05.2000
0,88
8,5%
9,7%
-12,08%
21,31%
V
30.06.2004
29.06.2006
2,00
11,50%
5,61%
7,70%
0,61%

11
TABLE III (A): GRANULARITY
TABLE III (B): GRANULARITY & EQUITY PERFORMANCE
GRAPH III: MAR RATIO vs GRANULARITY
Table as of 31 July 2015, Benchmark: Federal Funds Target Rate
Table as of 31 July 2015, Benchmark: Federal Funds Target Rate & S&P 500 Index
Here we define a normalised measure of the performance, the MAR Ratio, as the ratio of annualised
performance over maximum drawdown (MAR ratio = Annualised Performance / Maximum Draw-
down).
The findings of TABLES III (A) and (B) suggest that the lower the granularity (i.e. when interest rates
rise at a slow pace), the better the performance of equities appears to be. The same conclusion can be
drawn from GRAPH III, which shows the relationship between the MAR ratio and granularity, indi-
cating that equities have performed more strongly in periods of low granularity.
Source : Research Stlouisfed, JFD Brokers
Source : Research Stlouisfed, JFD Brokers, Stooq.com
Source : Research Stlouisfed, JFD Brokers, Stooq.com
PERIOD NUMBER
BEGIN DATE
END DATE
YIELD CHANGE (%)
ITERATIONS
GRANULARITY
I
31.03.1983
09.08.1984
3,00%
12
0,25000%
II
29.03.1988
17.05.1989
3,3125%
16
0,20703%
III
04.02.1994
01.02.1995
3,00%
7
0,42857%
IV
30.06.1999
16.05.2000
1,75%
6
0,29167%
V
30.06.2004
29.06.2006
4,25%
17
0,25000%
PERIOD NUMBER
GRANULARITY
MAX. DRAWDOWN
MAR RATIO
I
0,25%
5,75%
-14,38%
0,40
II
0,21%
25,0352%
-33,5100%
0,75
III
0,43%
-2,16%
-8,69%
-0,25
IV
0,29%
9,70%
-12,08%
0,80
V
0,25%
5,61%
-7,70%
0,73
Table as of 31 July 2015
0,80
0,60
0,40
0,20
0,00
-0,20
-0,40
0,00% 0,05% 0,10% 0,15% 0,20% 0,25% 0,30% 0,35% 0,40%

12
Source : Research Stlouisfed, JFD Wealth, Bloomberg
TABLE IV: PERFORMANCE OF BARCLAYS U.S. CREDIT INDEX DURING PAST RISING
RATE PERIODS
Table as of 31 July 2015
Interest rate rise expectations are causing fear among bond investors around the possible negative
impact on their portfolios. In general, as the fixed interest associated with the underlying securities
begins to appear less attractive with interest rate rises, the price of these instruments decreases. The
longer the bond’s maturity is, the more sensitive the instrument becomes to interest rate rises. Bonds
are therefore not all equally affected by interest rate changes.
To examine the relationship between interest rates and bond values of different market categories and
durations, we have chosen the following five benchmarks:
The findings of the performance of the various fixed income indices during previous periods of rising
interest rates are outlined in TABLES IV through VIII:
PERFORMANCE OF FIXED INCOME
SECURITIES DURING PREVIOUS
INTEREST RATE RISING CYCLES
NUMBER
1
2
3
4
5
INVESMENT TYPE1
Corporates
High Yield
Treasury
Treasury
Treasury
BLOOMBERG TICKER
Corporates
High Yield
Treasury
Treasury
Treasury
INDEX
Barclays US Credit Index
Barclays U.S. Corporate High Yield Index
Barclays U.S. 1-3 Year Treasury Bond Index
PERIOD NUMBER
BEGIN DATE
END DATE
LENGTH (YEARS)
MAX. DRAWDOWN
VOLATILITY
I
31.03.1983
09.08.1984
N.A
N.A
N.A
N.A
N.A
II
29.03.1988
17.05.1989
N.A
N.A
N.A
N.A
N.A
III
04.02.1994
01.02.1995
0,99
-3,20%
-3,23%
-7,64%
6,29%
IV
30.06.1999
16.05.2000
0,88
-0,1%
-0,2%
-3,87%
4,80%
V
30.06.2004
29.06.2006
2,00
5,54%
2,74%
-3,28%
3,68%

13
TABLE V: BARCLAYS CORPORATE HIGH YIELD PERFORMANCE DURING PAST RISING
RATE PERIODS
TABLE VI: BARCLAYS U.S. TREASURY 1-3 PERFORMANCE DURING PAST RISING RATE
PERIODS
TABLE VII: BARCLAYS U.S. TREASURY 3-7 PERFORMANCE DURING PAST RISING RATE
PERIODS
Table as 31 July 2015, Benchmark: Federal Funds Target Rate & Barclays Corporate High Yield
Table as 31 July 2015, Benchmark: Federal Funds Target Rate & Barclays U.S. Treasury 1-3
Source : Research Stlouisfed, JFD brokers, Stooq.com
PERIOD NUMBER
BEGIN DATE
END DATE
LENGTH (YEARS)
MAX. DRAWDOWN
VOLATILITY
I
31.03.1983
09.08.1984
N.A
N.A
N.A
N.A
N.A
II
29.03.1988
17.05.1989
N.A
N.A
N.A
N.A
N.A
III
04.02.1994
01.02.1995
0,99
-1,82%
-1,84%
-4,69%
4,66%
IV
30.06.1999
16.05.2000
0,88
-1,8%
-2,1%
-3,44%
2,60%
V
30.06.2004
29.06.2006
2,00
15,31%
7,40%
-5,29%
2,38%
PERIOD NUMBER
BEGIN DATE
END DATE
LENGTH (YEARS)
MAX. DRAWDOWN
VOLATILITY
I
31.03.1983
09.08.1984
N.A
N.A
N.A
N.A
N.A
II
29.03.1988
17.05.1989
N.A
N.A
N.A
N.A
N.A
III
04.02.1994
01.02.1995
0,99
1,24%
1,25%
-1,49%
2,03%
IV
30.06.1999
16.05.2000
0,88
3,5%
4,0%
-0,55%
1,25%
V
30.06.2004
29.06.2006
2,00
3,61%
1,79%
-0,81%
1,15%
PERIOD NUMBER
BEGIN DATE
END DATE
LENGTH (YEARS)
MAX. DRAWDOWN
VOLATILITY
I
31.03.1983
09.08.1984
N.A
N.A
N.A
N.A
N.A
II
29.03.1988
17.05.1989
N.A
N.A
N.A
N.A
N.A
III
04.02.1994
01.02.1995
0,99
-2,52%
-2,54%
-4,55%
3,94%
IV
30.06.1999
16.05.2000
0,88
2,2%
2,5%
-1,04%
2,42%
V
30.06.2004
29.06.2006
2,00
3,18%
1,58%
-1,83%
2,75%

14
All categories had their worst performance during period III, which experienced the highest granu-
larity. Furthermore, shorter term Treasuries performed the best when compared to the other four
categories during the same period. High yield and corporate bonds, as well as longer term Treasuries
performed better during the last period of lowest granularity.
TABLE VIII: BARCLAYS U.S. TREASURY 7-10 PERFORMANCE DURING PAST RISING RATE
PERIODS
PERIOD NUMBER
BEGIN DATE
END DATE
LENGTH (YEARS)
MAX. DRAWDOWN
VOLATILITY
I
31.03.1983
09.08.1984
N.A
N.A
N.A
N.A
N.A
II
29.03.1988
17.05.1989
N.A
N.A
N.A
N.A
N.A
III
04.02.1994
01.02.1995
0,99
-5,21%
-5,26%
-7,97%
6,11%
IV
30.06.1999
16.05.2000
0,88
1,5%
1,8%
-3,77%
5,63%
V
30.06.2004
29.06.2006
2,00
4,58%
2,27%
-4,72%
4,71%

15
A wide range of investors across the board,
including retirees living on fixed income as well
as institutional investors such as pension funds,
are all being squeezed by historically low interest
rates and therefore are desperately trying to
come up with alternative ways of generating suf-
ficient income sources for their portfolios.
Interest rates have been drifting lower all around
the globe during the past few years and have been
remaining at historic lows in several countries for
an extended period, however the economies that
begin to recover will experience rising interest
rates once again, catching both short as well as
long term fixed-income and equity investors off-
guard. What strategies can investors employ in
order to shield or even enhance their portfolios in
a rising interest rate environment?
There is no simple answer when it comes to the
manner in which rising interest rates affect var-
ious asset classes, due to the complexity of fac-
tors involved, such as the severity of the increase,
the magnitude of the rise, the frequency/time
length of incremental rises, as well as the state of
the economy.
When interest rates initially begin to rise during
an economic cycle, the impact on the stock
market is a positive one, as it is a reflection of the
improving economy.
PART II
ANALYSIS:SHIELDINGANDENHANCING
INVESTMENT PORTFOLIOS
SHIELDING AND ENHANCING
INVESTMENT PORTFOLIOS IN A RISING
INTEREST RATE ENVIRONMENT

16
The early stages of an economic expansion have therefore historically
been good for stock prices. If long-term interest rates are rising as the
result of stronger economic growth, then companies with cyclical earn-
ings should benefit. Many companies within the industrial and energy
sectors are commonly linked to economic growth, and in particular con-
sumerdiscretionarystockssuchasluxurybrands,tendtoexcelinperiods
of stronger economic growth.
In the later stages of the economic cycle, however, when the economy
begins to run too hot and prices increase too rapidly, the Fed would move
to slow economic growth through monetary policy by rising interest
rates, which could put a lid on stock market growth. Rising rates could
create a slowdown in housing, as well as possibly motivate stock inves-
tors to take profits off the table, selling stocks, reducing demand and
causing a decline.
Some types of stocks have more interest rate sensitivity than others.
They behave more like bonds and would likely see a drop in price as rates
move up, however other parts of the stock market would likely only
tumble if rates moved contrary to expectations.
THE FOUR PHASES OF ECONOMIC CYCLE
EA
RLY
RECE SSION
M
ID
LA
TE
4 PHASES
ActivityR ebounding
CreditBegi
nstoGrow
RapidProfi
tsGrowth
PolicyStillCumulative
LowInventories
Grow
t
h
Peaks
CreditGro
w
thStrong
ProfitGro
w
thPeaks
InventoriesS
alesGrowth
Equilibriu
m
Reached
Improvi
ngSales
GrowthM
oderates
Credit T
ightens
EarningsStruggling
Inventor
iesGrow
Sales Grow
thFalls
Grow
t
h
Peaks
CreditGro
w
th Strong
ProfitGro
w
th Peaks
InventoriesS
ales Growth
Equilibriu
m
Reached

17
A well-diversified, all-weather portfolio that will
withstand shocks throughout the various phases
of the economic cycle, is the most efficient ap-
proach towards the challenging task of correctly
timing the market. In general, based on the find-
ings of our study already outlined, there have
been periods during which stocks have benefitted
when interest rates rose. In fact, equities tend to
perform well if interest rates rise at a slow pace,
as long as the state of the economy is healthy and
improving; along with that improvement come in-
creased revenues and profits, therefore stocks do
not necessarily have to decline as rates rise. On
the other hand, due to the Fed’s low interest rate
policy, many bond investors have been forced to
find riskier assets. Rather than playing it safe with
Treasury securities or investment-grade corpo-
rate bonds, traditional fixed-income investors
have moved up the risk ladder to dividend-paying
stocks and other investments that pay a high div-
idend, such as real estate investment trusts (RE-
ITs).
Investors who have added high-dividend-paying
stocks such as those of utility, telecommunication
companies and REITs to their portfolios in the last
few years, might find it prudent to move away
from such investments which are interest rate
sensitive, and switch instead their portfolios to-
wards a more diversified, total return approach.
Moreover, there are a few different types of com-
panies which benefit from an economic uptick
and thrive in a rising rate environment, such as in-
formation technology and industrial companies.
An alternative strategy for hedging against the
risk of a selloff in the event that investors pan-
ic and rush for the exit when rates begin to rise
sharply, would be to switch into stocks of major
consumers of raw materials; the price of raw ma-
terials usually continues to remain stable or even
decline in a rising rate environment, while the
companies using these materials experience a
drop in their costs and consequently an increase
in their profit margins. Such companies are there-
fore considered to be a hedge against inflation
and rising rates.
In the context of international diversification,
global dividend stocks potentially offer higher
income and therefore outperformance. Emerging
market stocks, on the other hand, may experience
significant declines as the Fed begins the interest
rate hike process, as several emerging markets’
substantial U.S. debt exposure will become even
more burdensome in the event of U.S. interest
rate rises.
The primary purpose of bonds has historically
been to produce safe income for cash-flow needs.
In today’s low interest rate environment this is
extremely difficult to accomplish by investing in
government bonds, investment-grade bonds or
municipal bonds, as absolute yields are currently
zero to negative.
The secondary role of bonds within a diversified
portfolio is to insulate the portfolio from loss-
es during economic recessions and equity bear
markets. Typically, the Fed lowers interest rates
during recessions, extended market corrections
and the periodic bear market. As market interest
rates decline, the price of quality bonds and bond
REBALANCING THE FIXED INCOME
SECURITIES MIX
INVESTMENT ALTERNATIVES IN
EQUITIES

18
fund rises in response to these lower interest
rates. The positive performance of a quality bond
portfolio in times of stress helps to balance the
decline in risk assets such as stocks, as in the case
of the Asian contagion in 1997, the 2000–2002
bear market and the 2008 bear market.
As we have already seen in our study, the worst
place to be invested in when rates are rising, are
bonds or bond funds with long maturities and low
coupons, such as longer term Treasuries. These
securities are the most vulnerable to price de-
clines, as the principal will only be repaid in the
longer term and the low coupon is not sufficient
to compensate for the bond price drop due to the
rate rise.
When, however, interest rates rise more gradual-
ly and over a longer period of time, fixed income
underperformance is not as severe, since bonds
earn a higher amount of interest income over
this longer period, which in turn offsets the loss-
es from their price decline. Moreover, if rates are
rising for the right reasons—stronger economy,
more jobs, greater demand for loans/credit—then
high-yield bonds should hold up well, and float-
ing-rate bonds (such as bank debt) should also
perform well.
Therefore a rising rate environment is not neces-
sarily a bad thing when it does not happen in an
abrupt, uncontrolled manner, as it could actual-
ly allow investors who need income, to reinvest
principal that comes due from their bonds at high-
er rates. What would raise a concern, however, is
the potential behaviour of bond investors panick-
ing in the event of a rate rise and a price decline
in their bond holdings, as many of them would be
rushing for the exit and this could, at least in the
short term, cause a disruption in the liquidity and
pricing of all bond types.
Furthermore, bonds with higher coupons and
shorter duration such as high-yield corporate
bonds (or junk bonds), are better insulated from
price declines. These are bonds issued by cor-
porations that are below investment grade and
usually offer higher coupons in order to attract
capital. The higher coupon and generally short-
er maturities imply a lower price sensitivity to
interest rate changes. As long as the economy is
robust and the issuing companies of these corpo-
rate bonds are healthy, bond prices tend to be less
affected by rising rates than investment-grade
corporate bonds, as the higher-coupon (or yield)
helps to absorb price declines.
Floating-rate bonds is another category of invest-
ments issued by corporations below investment
grade and they also better insulated from price
declines. These bonds pay a floating rate of in-
terest that typically adjusts monthly or quarterly.
There are two advantages to these investments:
(a) when shorter-term rates rise, the interest paid
by these bonds increases when they hit the reset
period (monthly or quarterly), and (b) the price
sensitivity of these bonds is much lower because
of the periodic interest-rate reset. Therefore, the
pricing of these bonds is more stable during rising
rate environments.
Furthermore, it is wise to keep sufficient cash
and/or very short duration bonds in the portfolio,
in order to be able to meet any spending needs
that may arise in the 12 to 18 months that follow
an interest rate rise.
Bond laddering is an effective strategy of restor-
ing balance and discipline in fixed income portfo-
lios when approaching a period of rising interest
rates. It involves keeping the fixed-income part of
the portfolio relatively liquid, by holding a series
of bonds maturing at regular intervals (such as ev-
ery three, six, nine or 12 months), so that as rates
rise and as each bond matures, it gets reinvested
at a higher rate.
Holding the right mix of bonds (government
bonds, municipal bonds, investment-grade, high-
yield corporates, floating-rate, etc.) and timely
rebalancing it accordingly, is the key to insulating
and enhancing an investment portfolio. Signifi-
cantly reducing the holdings with longer matur-
ities and lower yields (investment grade bonds)
and switching them into high-yield and high-qual-
ity non-investment grade corporate bonds, as
well as long/short bond funds, are alternative
solutions for hedging some of the inherent risks
associated with price declines when interest
rates eventually rise.

19
The proportion of an investor’s assets allocated
to bonds and other categories may well be the
most important decision investors make. Allo-
cating money across stocks, bonds and cash, is
far more significant on long-term returns than
individual investment selection. In periods of
approaching interest rate rises, it becomes even
more important to adjust the asset allocation mix
in order to protect the return of the portfolio.
For many years, the rule of thumb for most long-
term investors was 60/40, a 60 percent allocation
in stocks and 40 percent in bonds. Besides being
a simple rule, less volatile and lower-return bonds
were meant to smooth out the ups and downs of
the riskier stock market while giving investors
some of the greater possible gains of stocks.
According to Vanguard, an investor with a 60/40
allocation can expect an average annual return of
8.9%, based on data going back to 1926.
However,thetraditional60/40approachtowards
building a portfolio is now being replaced by “tac-
tical” asset allocation, a strategy in which inves-
tors change their allocation based on the current
pricing of asset classes. If bonds are overpriced,
and stocks are under-priced relative to other
assets, then the allocation should shift toward
stocks and always balance out the riskier assets
in a portfolio.
One strategy would be to reduce the amount
invested in high-yield bonds and move it into
stocks that pay high dividends, using an options
strategy to lock in gains and protect against
market drops, or maintain a large allocation in
fixed income, but weigh it heavily towards Trea-
sury inflation-protected securities (TIPS), whose
yields rise with inflation.
ADJUSTING THE ASSET ALLOCATION
OF THE PORTFOLIO
THE MIXTURE OF ASSETS DEFINES THE SPECTRUM OF RETURNS
Best, worse, and average annual returns for various bonds/stocks allocations, 1926-2014
Note: Past performances does not guarantee future results. The performance of an index is not an exact representation of any particular
investment, as you cannot invest directly in an index.
Stocks are represented by the Standard & Poor’s 90 Index from 1926 through March 9, 1957, the S&P 500 Index from March 4, 1957, through
1974; the Dow Jones Wilshire 5000 Index from 1975 through April 22, 2005; the MSCI US Broad Market Index from April 23, 2005, to June
2, 2013; and CRSP US Total Market Index thereafter. Bonds are represented by S&P High Grade Corporate Index from 1926 through 1968;
the Citigroup High Grade Index from 1969 through 1927; Barclays U.S. Long Credit AA Index from 1973 through 1975; and the Barclays U.S.
Aggreegate Bond Index thereafter. Data are through December 31, 2014.
Source: Vanguard.
BONDS
STOCKS
100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0%
0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%
60%
50
40
30
20
10
0
-10
-20
30
-40
-50
32.6% 31.2% 29.8% 28.4% 27.9%
-18.4%
32.3%
-22.5%
-26.6% -30.7%
-34.9%
-39.0%
-43.1%
36.7% 41.1%
46.4%
49.8% 54.2%
Average
-8.1% -8.2% -10.1%
-14.2%
5.5% 6.1% 6.8% 7.4% 7.9% 8.4% 8.9% 9.3% 9.6% 9.9% 10.2%

20
In general, precious metals such as gold, which are tangible assets, per-
form better in a low interest rate and rising inflation environment. When
interest rates start to move higher in order to curb inflation, however, the
performance of such inflation hedging investments deteriorates.
Furthermore, oil and other natural resources also suffer in a rising in-
terest rate environment. As already mentioned, an alternative to hedge
against inflation would be to hold stocks of companies that consume such
resources, as the cost of material goes down and the profit margins for
these companies increase.
The housing market is heavily dependent on mortgage lending. Rising
interest rates trigger a plummet in housing along with mortgage applica-
tions, as they make it more costly to buy a home. Furthermore, a contrac-
tion in the housing market has a negative effect on related businesses
such as manufacturers of appliances and items used in the home con-
struction process. A weak housing market can also hinder the banking
sector as it reduces loan activity.
Prudent investors could lock their debt/mortgage at current rates ahead
of an expected rise. Investors who are eligible to refinance their house,
would be currently urged to do so. Although it is often difficult to predict
the exact time and magnitude of a rate increase, if eligible, it is advised to
take the opportunity to refinance while interest rates are still at historic
lows and avoid a steep increase in loan repayments.
HEDGING AGAINST
INFLATION
HOUSING SECTOR AND
DEBT REFINANCING

21
When interest rates rise as a consequence of a
monetary policy tightening, the value of the cur-
rency tends to increase as higher interest rates
tend to attract global investors to U.S. denom-
inated income yielding investments and bank
deposits, thus boosting demand for the currency.
The greatest challenge of having a strong U.S.
Dollar occurs at a macro level, as it could pose
a significant impact on the Balance of Trade,
causing a rise of imports and decline in exports as
U.S. goods and services become more expensive;
as a consequence, American exporting compa-
nies suffer and eventually economic growth and
hiring are hampered. Moreover, major U.S. mul-
tinationals suffer from an erosion of their profits
when they translate their overseas earnings into
U.S. Dollars.
The biggest losers from a stronger dollar in a
healthy economic environment, however, will
are the corporate borrowers. The rise in interest
rates assumes that the cost of borrowing also
increases. Domestic companies tend to borrow
money at a faster pace in an effort to lock in
their loan and bond rates at lower interest rates
ahead of a potential rise. While in a historic low
interest rate environment these companies have
benefited from cheap borrowing which enabled
them to buy back shares as well as pay dividends
to shareholders, which in turn has made them
appear more attractive to market participants,
all of these benefits are poised to end as soon as
interest rates begin to rise.
Most importantly, a stronger U.S. Dollar effec-
tively transfers demand from the U.S. economy
to other economies around the globe. A stronger
U.S. currency makes domestic products appear
lesscompetitiveintheinternationalmarket,while
the products of other struggling economies with
weaker currencies such as Europe and Japan will
appear more attractive and their exports could be
boosted on the back of a stronger U.S. Dollar.
Therehavebeenthreemajorperiodsofastronger
U.S. Dollar since the recession of 1973-1975.
During the first period, October 1978 – March
1985, the U.S. Dollar strengthened by more than
52.50 percent, while the S&P 500 index surged
by more than 70.00 percent. The second period
which occurred from mid-1005 to early-2002,
during which the U.S. Dollar appreciated by 35.00
percent while the S&P 500 index gained more
than 100.00 percent. In the third period which is
still underway, the U.S. Dollar has risen sharply by
more than 25.00 percent between the trough in
mid-2011 and the peak in February 2015.
In our study we have observed the behavior of the
U.S.Dollarindexduringthethreeaforementioned
major periods. The U.S. Dollar index is defined as
a measure of the value of the U.S. Dollar relative
to a basket of several major currencies, namely
the Euro, Japanese Yen, British Pound, Canadian
Dollar, Swedish Krona and the Swiss Franc.
THE IMPACT ON THE CURRENCY AND
THE IMPORTANCE OF CURRENCY
DIVERSIFICATION

22
OutofthefiveperiodsexaminedearlierinGRAPH
II when the Fed increased interest rates, only in
one case the U.S. Dollar index appreciated when
a sharp increase of 1.50 percent was recorded,
whereas in two cases the currency depreciated
and in the other two it remained unchanged.
More specifically, the Fed increased interest rates
in May 1982 through October 1983 from 8.50
to 10.00 percent, while at the same time the U.S.
Dollar index experienced high gains exceeding
Source : Macrotrends.net
Source : jfdbrokers.com
GRAPH IV: U.S. DOLLAR INDEX HISTORY
GRAPH V: U.S. DOLLAR INDEX AND S&P 500 INDEX PERFORMANCE
As indicated in GRAPHS IV and V, each of the three long periods of U.S. Dollar strength coincided with
higher stock prices, as U.S. equities tend to perform well as a result of capital flowing from around the
world into investments and deposits in the United States.
130
1975 1980 1985 1990 1995 2000 2005 2010 2015
1978 - 1985
1995 - 2002
2011 - 20??
125
120
115
110
105
100
95
90
85
80
Real Dollar Index - Broad Real Dollar Index - Major Real Dollar Index - Other
120%
Oct. '78 - Mar. '85 Jul. '95 - Feb. '02 Jul. '11 - Feb. '15
100%
80%
60%
40%
20%
0%
U.S. Dollar Index
%CHANGE
S&P 500 Index
52.5%
75.5%
35.8%
103.2%
25.8%
58.9%

23
$10.00. Interestingly enough, this rise in the
U.S. Dollar index coincides with the first phase
of a strong U.S. Dollar during the 1978 to 1985
period, as shown in GRAPH IV.
The second phase of ten consecutive Fed rate
hikes occurred from January 1987 to February
1988, lifting the interest rate from 6.50 to 9.75
percent.TheU.S.Dollarindexsufferedhugelosses
prior to the Fed’s rate action, from the $128.45
peak level in March 1985 down to $102.00 at the
start of the interest rate rise process in January
1987. In this case, the Fed action did not prevent
the negative momentum of the currency and the
sharp correction continued to cause a plunge of
more than $35.00 in the U.S. Dollar index from its
March 1985 peak.
From February 1993 to February 1994, while the
Fed increased its benchmark rate from a record
low of 3.00 percent all the way up to 6.00 percent,
the U.S. Dollar index level remained unchanged
and moved in a sideways channel roughly around
the $90.00 region.
Following the trough below the $85.00 level on
December 1994, the U.S. Dollar index gained
more than $20.00 during a strong U.S. Dollar
era that persisted for seven years, from 1995 to
2002. The U.S. Dollar index consequently paused
roughly around the $105.00 region despite the
rate increase during the period of June 1998 -
May 1999, when the Fed decided to increase its
benchmark rate from 5.00 to 6.50 percent.
The bull market of the U.S. Dollar index ended
in February 2002 when the index reached a sev-
enteen year high at $116.65. In December 2003
the U.S. Dollar index came under pressure and fell
below the critical level of $100.00 during the bear
market of the 2002 - 2011 period and recorded
two critical consecutive troughs, the first one
at $84.40 in April 2008 and the second one at
$80.50 in July 2011.
The most recent interest rate rise action by the
Fed was recorded prior to the global financial
crisis of 2006. During the period of June 2003
- June 2005, the interest rate was increased
seventeen consecutive times, from 1.00 to 5.25
percent, and remained at the latter level during
the year that followed. The impact of this action
on the U.S. Dollar index was surprising to many
market participants, as it experienced a sharp
correction of more than 10.00 percent annually
during this period.
Since the two troughs below the $85.00 level in
April 2008 and July 2011, the U.S. Dollar index
has been moving one way, gaining more than
20.00 percent over the past four years.
The U.S. Dollar poses a dilemma to Fed poli-
cymakers as they face the challenging task of
addressing the need to increase interest rates in
a growing economy in order to achieve their eco-
nomic goals, while maintaining market calm and
stability. The currency strength became more
apparent over the last couple of years, especially
since the second quarter of 2014, on the back
of the Fed officials’ comments opening the door
to the possibility of an interest rate increase as
the U.S. economy started to show healthy signs
of recovery. The anticipation of a rate rise signal
from the Fed, has triggered a flow of funds into
U.S. Dollar denominated assets in search of
higher returns, lifting the value of the currency to
higher levels.
The same argument applies to the performance
of the British Pound, as several Bank of England
policymakers have noted that the possibility of
an interest rate hike decision may be possible in
the next few months (this will be the subject of an
analysis in one of our future case studies under
our White Paper series).

24
Source : Saxobank
GRAPH VI: COMPARISON OF U.S. DOLLAR INDEX AND S&P 500 INDEX
In addition to the importance of increasing the
exposure of strengthening major currencies
in the portfolio such as the U.S. Dollar and the
British Pound, avoiding investments in emerging
markets denominated currencies would be rec-
ommended when discussing currency diversi-
fication. As already mentioned earlier under
“Investment Alternatives in Equities”, a U.S. rising
interest rate environment will trigger U.S. Dollar
appreciation against other currencies and espe-
cially those of emerging market economies; the
total debt burden of these economies amounts to
several trillions of U.S. Dollars which will become
even heavier as their debt in real local-currency
value will increase due to the U.S. Dollar appre-
ciation, causing a shock on financial institutions,
corporations, households as well as the local cur-
rencies.
125
115
120
110
100
105
95
85
90
80
70
65
75
U.S. Dollar Index S&P 500 Index
1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

25
In this paper we have studied the behavior of investment portfolios
with regards to performance and risk measurements during previous
interest rising cycles going back to 1982. Our findings show that when
interest rates rise at a slow pace, in general both equities and bonds have
appeared to record better performance during periods of slow-paced
interest rates rises.
Due to the complexity of factors involved, however, such as the severity
of the increase, the magnitude of the rise, the frequency/time length of
incremental rises, as well as the state of the economy, predicting exactly
how major asset classes such as stocks and bonds will behave when
interest rates start to rise, is a difficult task.
Whilewehaveoutlinedanumberofstrategiesforrebalancinginvestment
portfolios in order to protect and enhance them as we head towards the
start of a series of interest rate rises in major global economies such as
the U.S. and the U.K., it still remains an extremely challenging job. Bottom
line is, however, that that all asset allocation plans must always be tai-
lored to each investor’s circumstances and risk tolerance.
Furthermore, based on the continuing improvement of the U.S. economy
and the Federal Reserve Fed rhetoric signaling that a period of rising
rates may be on track during the last quarter of this year, the expecta-
tions for U.S. Dollar interest rates to begin rising are quite high, which
would in turn further boost the U.S. Dollar value against other currencies
as it will attract foreign capital to U.S. Dollar denominated instruments. It
is therefore extremely important to take into account the potential out-
performance of currencies such as the U.S. Dollar (as well as the British
Pound) over other major currencies in the context of currency diversifi-
cation of an investment portfolio.
CONCLUSION

26
Anthony LESOISMIER
Head of Financial Market Advisory
Main: +357 25 878530 | Fax: +357 25 763540
Efthivoulos GRIGORIOU
Head of Global Research and Analysis
Main: +357 25 878530 | Fax: +357 25 763540
CONTACTS

27
DISCLAIMER
The information contained herein is based on sources we believe reli-
able, but we do not guarantee its accuracy, and it should be understood
to be general insurance/reinsurance information only. The Authors make
no representations or warranties, express or implied. The information is
not intended to be taken as advice with respect to any individual situ-
ation and cannot be relied upon as such. Readers are cautioned not to
place undue reliance on any historical, current or forward-looking state-
ments. The Authors undertake no obligation to update or revise publicly
any historical, current or forward-looking statements, whether as a re-
sult of new information, research, future events or otherwise.
This notice is provided to you in agreement with the Markets in Financial
Instrument Directive (MiFID) of the European Union. JFD Brokers Ltd.
does not warranty the initial capital of the Clients portfolio or its value
at any time or any money invested in any financial instrument. The Cus-
tomer should completely acknowledge and accept that he runs a great
risk of incurring losses and damages and accepts and confirms that he is
prepared to take on this risk. Information of the previous performance
of a Financial Instrument does not guarantee its current and/or future
performance. There are no guarantees of profit no matter who is manag-
ing Customer’s money. The Customer recognizes and accepts that there
may be other risks which are not covered above. The Customer should
take the risk that the undertaken trades in specific Financial Instruments
may be or become conditional on tax and/or any other duty. The Custom-
er is fully aware that the trading in Financial Instrument on his behalf is
extremely risky and may cause complete loss of all his money and simi-
larly of any extra commissions and other charges incurred. JFD Brokers
Ltd. does not guarantee that there will be no outstanding tax and/or any
other stamp duty incurred. The Customer should be accountable for any
taxes and/or any other duty which may accumulate in respect of the ex-
ecuted trades.
JFD Wealth is a trademark of JFD Brokers Ltd. Trading Foreign Exchange
and Contracts for Difference (CFDs) is highly speculative and may not
be suitable for all investors. JFD Brokers offers trading on margin. The
leverage created by trading on margin can work against you as well as
for you, and losses can exceed your entire investment. Only invest with
money you can afford to lose and ensure that you fully understand the
risks involved. Seek independent advice if necessary and review our Risk
Disclosure and Privacy Disclosure on www.jfdbrokers.com, before open-
ing an account.
Copyright © 2015 JFD Brokers Ltd.

Kakos Premier Tower Kyrillou Loukareos 70 4156 Limassol Cyprus
Main +357 2587 8530 I Fax +357 2576 3540
info@jfdwealth.com I www.jfdwealth.com I www.jfdchange.com
JFD Wealth is a trademark of JFD Brokers Ltd.

JFD-WEALTH_WHITE-PAPER-SERIES_1

Recommended

Recommended

More Related Content

What's hot

What's hot (20)

Viewers also liked

Viewers also liked (12)

Similar to JFD-WEALTH_WHITE-PAPER-SERIES_1

Similar to JFD-WEALTH_WHITE-PAPER-SERIES_1 (20)

JFD-WEALTH_WHITE-PAPER-SERIES_1