The investment management firm said as the Fed begins to tighten policy this will lead to periods of heightened volatility.
T. Rowe Price head of international fixed income Arif Husain said credit spreads have significantly tightened amid strong appetite and investor demand for yield.
“At current levels, investment-grade and high-yield spreads offer investors little buffer if macro events or deteriorating fundamentals send them wider,” said Mr Husain.
He said investors should hedge credit risk by combining long positions in the highest-conviction names with short positions in various credit derivative indexes.
“This allows portfolio managers to extract credit alpha from well-researched individual names while neutralising market risk,” he said.
T. Rowe Price also holds small positions likely to lose money in a benign market environment but perform well if risk aversion suddenly intensifies, said Mr Husain.
Safe haven currencies such as the US dollar and the Japanese yen, he said, have historically risen in value during periods of investor fear.
“Having modest exposure to these top-tier reserve currencies can potentially limit losses from higher-risk positions if investor sentiment turns negative,” he said.
Mr Husain also warned investors to stay underweight in currencies attracting speculators who borrow in low-yielding currencies such as the euro to capture the yield differential.
“New Zealand and Turkey have recently been popular destinations,” he said.
“These crowded carry trades can quickly unwind when there are signs of market stress or a change in the fundamental story.”
Mr Hussain said while defensive positions may require sacrificing some yield and performance, it reduces downside risk and threats to income.
He said this should be of the utmost concern for most bonds investors when yields are low and volatility is subdued.
“While the precise timing and catalyst are difficult to predict, we can be sure that both will rise at some point,” he said.
