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How Rising Treasury Yields Impact Your Portfolio

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This infographic is available as a poster.

How Rising Treasury Yields Impact Your Portfolio

Treasury Yields

This infographic is available as a poster.

How Rising Treasury Yields Impact Your Portfolio

Since the start of 2021, the yield on the U.S. 10-year Treasury note has climbed to pre-pandemic levels. But what exactly does this mean, and how could it impact your portfolio?

In this Markets in a Minute from New York Life Investments, we explain why Treasury yields are important and which investments may go up or down when yields are rising.

What are Treasury Yields?

Treasury yields are the total amount of money you earn from U.S. debt securities, such as bonds and T-bills. Yields depend on both the security’s price, relative to its face value, and its “coupon” or interest payment.

The 10-year yield is important because it is closely-watched indication of market sentiment. Here’s what leads to changing Treasury yields:

  1. When investors expect the market to drop, they look for safer investments.
  2. Due to higher bond demand, prices rise.
  3. This lowers their yield, as bonds become more expensive than they were before.

The opposite occurs when the market is bullish.

  1. When investors expect the market to rise, they look for riskier investments.
  2. Due to less bond demand, prices drop.
  3. This raises their yield, as bonds become more cost effective.
    1. Currently, Treasury yields are in the latter scenario because investors are confident in a sustained recovery as vaccines are rolled out and the economy reopens.

      Investments That May Go Up During Rising Yields

      Rising yields can have a number of knock-on effects in the market. Here are the investments that could increase in value when yields are going up.

      InvestmentWhy could returns potentially increase?
      U.S. dollarRising yields attract income-seeking investors, who must purchase U.S. debt in U.S. dollars
      Savings accountsIf the economy is growing at a rate that may lead to hyperinflation, the central bank may raise interest rates 
      REITsWhile rising rates pose challenges, economic growth typically translates into a higher level of real estate demand
      Cyclical stocksStocks that move with the economy, like banks, tend to do well during economic recoveries

      Cyclical stocks, such as banks, travel, and energy, may all benefit from an economic recovery. This is particularly true for banks if the economy is growing at a rate that exceeds inflation targets, as the central bank may raise interest rates. In turn, this allows banks to earn a higher profit margin because they can charge a higher rate on their loans.

      While it is commonly said that real estate investment trusts (REITs) underperform during rising interest rates, the data tells a different story. In four of six periods of sustained rising yields, REITs earned positive returns—and they outperformed stocks in half of them.

      REIT Performance During Rising Treasury Yields

      Source: S&P Dow Jones Indices

      Rising rates do pose challenges, including higher borrowing costs and lower property values.

      However, it’s evident that rising rates also have a positive influence on REITs. For instance, rising rates are typically associated with economic growth, which translates to higher real estate demand and higher occupancy rates. This means REITs can see increased earnings and dividends.

      Investments That May Go Down During Rising Yields

      On the flip side, there are some investments that could decrease in value when yields climb.

      InvestmentWhy could returns potentially decrease?
      BondsTo remain competitive, newly issued bonds offer higher interest rates—making existing bonds less attractive
      Dividend-paying stocksRising rates give an edge to newly issued bonds, creating a historically safer alternative for income-seeking investors
      GoldAs a safe haven asset, gold is less desirable during market optimism
      Some growth stocksRising interest rates make borrowing more expensive, which may slow company growth

      Existing bonds will likely see declining performance, with higher volatility among long-term government and corporate bonds. Short-term bonds typically see smaller drops. This is because they have less interest rate risk: there’s a smaller probability that interest rates will rise before a short-term bond’s maturity, and they have fewer interest payments that could be affected by rising rates.

      Growth stocks, such as those in the technology sector, may also see weaker performance. In fact, value stocks have been outperforming growth stocks since the fourth quarter of 2020, a significant shift from growth’s strong historical performance in recent years.

      U.S. Treasury Yields: One Part of the Picture

      In addition to being a barometer for investor confidence, Treasury yields can have an important impact on your portfolio.

      However, investment performance can vary depending on a number of other economic factors such as inflation and interest rate levels. For example, climbing inflation could lead to higher gold prices, since gold is seen as an inflationary hedge. You may want to consider the full economic picture when you are reviewing your portfolio.

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Markets in a Minute

What is the Success Rate of Actively Managed Funds?

For actively managed funds, the odds of beating the market over the long run are like finding a needle in a haystack.

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Actively Managed Funds

What is the Success Rate of Actively Managed Funds?

Over a 20-year period, 95% of large-cap actively managed funds have underperformed their benchmark.

The above graphic shows the performance of actively managed funds across a range of fund types, using data from S&P Global via Charlie Bilello.

Missing the Mark: Actively Managed Funds

Several factors present headwinds to actively managed funds.

  • Trading costs: First, fund managers will trade more often than passive funds. These in turn incur costs, impacting returns.
  • Cash holdings: Additionally, many of these funds hold a cash allocation of about 5% or more to capture market opportunities. Unlike active funds, their passive counterparts are often fully invested. Cash holdings can have the opposite effect than intended—dragging on overall returns.
  • Fees: Active funds can charge up to 1-2% in investment manager fees while funds that tracked an index passively charged just 0.12% on average in 2022. These additional costs add up over time.

Below, we show how active funds increasingly underperform against their benchmark over each time period.

Fund Type1 Year
% Underperformed
5 Year
% Underperformed
10 Year
% Underperformed
20 Year
% Underperformed
All Large-Cap 51879195
All Small-Cap 57718994
Large-Cap Growth 74869698
Large-Cap Value 59698587
Small-Cap Growth 80598597
Small-Cap Value 41819192
Real Estate 88627487

As we can see, 51% of all large-cap active mutual funds underperformed in a one-year period. That compares to 41% of small-cap value funds, which had the best chance of outperforming the benchmark annually. Also, an eye-opening 88% of real estate funds underperformed.

For context, Warren Buffett’s firm Berkshire Hathaway has beat the S&P 500 two-thirds of the time. Even the world’s top stock pickers have a hard time beating the market’s returns.

2020 Market Crash: A Case Study

How about active funds’ performance during a crisis?

While the case for actively managed funds is often stronger during a market downturn, a 2020 study shows how they continued to underperform the index.

Overall, 74% of over 3,600 active funds with $4.9 trillion in assets did worse than the S&P 500 during the 2020 market plunge.

Stage of 2020 CycleTime Period% Underperforming S&P 500
CrisisFeb 20 - Apr 30, 202074.2
CrashFeb 20 - Mar 23, 202063.5
RecoveryMar 24 - Apr 30, 202055.8
Pre-CrisisOct 1 2019 - Jan 31, 202067.1

Source: NBER

In better news, roughly half underperformed through the recovery, the best out of any market condition that was studied.

The Bigger Impact

Of course, some actively managed funds outperform.

Still, choosing the top funds year after year can be challenging. Also note that active fund managers typically only run a portfolio for four and a half years on average before someone new takes over, making it difficult to stick with a star manager for very long.

As lower returns accumulate over time, the impact of investing in active mutual funds can be striking. If an investor had a $100,000 portfolio and paid 2% in costs every year for 25 years, they would lose about $170,000 to fees if it earned 6% annually.

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Markets in a Minute

Ranked: The Largest Bond Markets in the World

The global bond market stands at $133 trillion in value. Here are the major players in bond markets worldwide.

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The Largest Bond Markets in the World

The Largest Bond Markets in the World

In 2022, the global bond market totaled $133 trillion.

As one of the world’s largest capital markets, debt securities have grown sevenfold over the last 40 years. Fueling this growth are government and corporate debt sales across major economies and emerging markets. Over the last three years, China’s bond market has grown 13% annually.

Based on estimates from the Bank for International Statements, this graphic shows the largest bond markets in the world.

ℹ️ Total debt numbers here include both domestic and international debt securities in each particular country or region. BIS notes that international debt securities are issued outside the local market of the country where the borrower resides and cover eurobonds as well as foreign bonds, but exclude negotiable loans.

Ranked: The World’s Top Bond Markets

Valued at over $51 trillion, the U.S. has the largest bond market globally.

Government bonds made up the majority of its debt market, with over $26 trillion in securities outstanding. In 2022, the Federal government paid $534 billion in interest on this debt.

China is second, at 16% of the global total. Local commercial banks hold the greatest share of its outstanding bonds, while foreign ownership remains fairly low. Foreign interest in China’s bonds slowed in 2022 amid geopolitical tensions in Ukraine and lower yields.

Bond Market RankCountry / RegionTotal Debt OutstandingShare of Total Bond Market
1🇺🇸 U.S.$51.3T39%
2🇨🇳 China$20.9T16%
3🇯🇵 Japan$11.0T8%
4🇫🇷 France$4.4T3%
5🇬🇧 United Kingdom$4.3T3%
6🇨🇦 Canada$4.0T3%
7🇩🇪 Germany$3.7T3%
8🇮🇹 Italy$2.9T2%
9🇰🇾 Cayman Islands*$2.7T2%
10🇧🇷 Brazil*$2.4T2%
11🇰🇷 South Korea*$2.2T2%
12🇦🇺 Australia$2.2T2%
13🇳🇱 Netherlands$1.9T1%
14🇪🇸 Spain$1.9T1%
15🇮🇳 India*$1.3T1%
16🇮🇪 Ireland$1.0T1%
17🇲🇽 Mexico*$1.0T1%
18🇱🇺 Luxembourg$0.9T1%
19🇧🇪 Belgium$0.7T>1%
20🇷🇺 Russia*$0.7T>1%

*Represent countries where total debt securities were not reported by national authorities. These figures are the sum of domestic debt securities reported by national authorities and/or international debt securities compiled by BIS.
Data as of Q3 2022.

As the above table shows, Japan has the third biggest debt market. Japan’s central bank owns a massive share of its government bonds. Central bank ownership hit a record 50% as it tweaked its yield curve control policy that was introduced in 2016. The policy was designed to help boost inflation and prevent interest rates from falling. As inflation began to rise in 2022 and bond investors began selling, it had to increase its yield to spur demand and liquidity. The adjustment sent shockwaves through financial markets.

In Europe, France is home to the largest bond market at $4.4 trillion in total debt, surpassing the United Kingdom by roughly $150 billion.

Banks: A Major Buyer in Bond Markets

Like central banks around the world, commercial banks are key players in bond markets.

In fact, commercial banks are among the top three buyers of U.S. government debt. This is because commercial banks will reinvest client deposits into interest-bearing securities. These often include U.S. Treasuries, which are highly liquid and one of the safest assets globally.

As we can see in the chart below, the banking sector often surpasses an economy’s total GDP.

Banking Sector

As interest rates have risen sharply since 2022, the price of bonds has been pushed down, given their inverse relationship. This has raised questions about what type of bonds banks hold.

In the U.S., commercial banks hold $4.2 trillion in Treasury bonds and other government securities. For large U.S. banks, these holdings account for almost 24% of assets on average. They make up an average 15% of assets for small banks in 2023. Since mid-2022, small banks have reduced their bond holdings due to interest rate increases.

As higher rates reverberate across the banking system and wider economy, it may expose further strains on global bond markets which have expanded rapidly in an era of dovish monetary policy and ultra-low interest rates.

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