Interest Rate Fears Have Motivated Investors To Share Strategies - Including One That Outperformed The 60/40 Rule

Due to renewed fears that interest rates will remain higher for longer, the markets are jittery.

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Despite the downturn in stocks on Tuesday, the yield on the 2-year Treasury note jumped to 5%, the highest level since 2007.

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What is the best way for investors to trade in such an uncertain market? BlackRock and other industry experts have weighed in on the matter.

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ETFs that follow the barbell strategy

The hawkish commentary from the U.S. Federal Reserve and personal consumption expenditure data have forced investors to confront the sobering truth, said Gargi Chaudhuri, head of iShares Investment Strategy at BlackRock. She said that the rates are going to remain “higher for longer,” so they will continue to rise.

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“With imminent policy rate cuts priced out and the long end of the Treasury curve creeping over 4%, we believe rates have finally reached a level to provide an appropriate entry point,” she said in a March 7 note.

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For the moment, BlackRock recommends barbell an overweight allocation to short-duration fixed income with an allocation to longer-duration, high-quality fixed income. Bonds purchased with a barbell strategy are short-term and long-term bonds, but not intermediate-term bonds. 

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BlackRock recommends the following:

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Fixed-income funds that invest in short-duration bonds include the iShares 0-3 Month Treasury Bond ETF, the iShares Short Treasury Bond ETF, and the iShares Treasury Floating Rate Bond ETF.

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Fixed-income funds with a longer duration include iShares TIPS Bond ETF, iShares Core U.S. Aggregate Bond ETF, and iShares MBS ETF.

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These types of stocks are worth considering

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The firm says it does not believe investors will be adequately rewarded by "aggressive" allocations to stocks. This is because 6-month Treasury bills are yielding over 5% and the S&P 500 is hovering around the 4,000 mark.

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“Even though we do not recommend investors give up on stocks altogether, we do believe in a “higher for longer” environment, investors should gravitate towards value-style stocks,” Chaudhuri said.

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Investing in value-oriented stocks can be done using equity exchange-traded funds (ETFs), such as the iShares MSCI USA Value Factor ETF, iShares Russell 1000 Value ETF, and the iShares Core High Dividend ETF.

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Bonds may have become more attractive as Treasury yields approach their highest levels in a decade, but certain top dividend-paying stocks also provide competitive payoffs to investors. 

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This strategy beat the ’60/40′ model

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Since 1926, 2022 has been one of the worst years for traditional "60/40" investment portfolios (an investment strategy in which 60% of the money is invested in stocks and 40% in bonds) as a result of market downturns. As of now, it has gained 6.2% in January - although that was during a time when the markets were rallying.

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Wells Fargo Investment Institute reports that one strategy beat the 60/40 mix last year, when markets were down, and even during the 2019 market rally.

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The equity hedge strategy is one in which investors earn positive returns by both buying stocks that do well and short-selling stocks that are doing poorly to make a profit.

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“During the years 2020 and 2022, equity hedge funds generated value by managing exposure dynamically,” the company’s strategists explained in a March 6 note. By using leverage and various hedging methods to “dynamically adjust” their exposure in difficult markets, hedge funds are able to “prove advantageous to investors.”

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“Our belief is that conditions may be set up in such a way that the Equity Hedge strategy could potentially benefit in the future,” they said, adding that the return to higher interest rates may widen the gap between strong and weak companies as they struggle to compete in the market.

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In the long run, Wells Fargo points out, that will make it easier for fund managers with better stock-picking skills to take advantage of this disparity.