The Strategic Case for Securitized Bond Investing in a Rising Rate Environment

In an era of persistent inflation and tightening monetary policy, fixed income investors face a paradox: rising interest rates threaten traditional bond portfolios, yet the hunt for yield has created fertile ground for strategies that defy conventional benchmarks. Diamond Hill’s Intermediate Bond Strategy exemplifies this duality, leveraging securitized markets to deliver risk-adjusted returns that outpace the Bloomberg US Intermediate Aggregate Bond Index while navigating the turbulence of a rising rate environment.

A Differentiated Approach to Duration and Credit

The Bloomberg US Intermediate Aggregate Bond Index, a proxy for the broad U.S. bond market, returned 0.56% net of fees in the past quarter (July 2025) [1]. By contrast, Diamond Hill’s Intermediate Bond Strategy posted a 0.78% return for the same period, outperforming its benchmark despite a backdrop of rate hikes and economic uncertainty [1]. This edge stems from the fund’s deliberate focus on securitized products—mortgage-backed securities, asset-backed securities, and other structured instruments—where market inefficiencies persist.

Securitized markets, historically less crowded than corporate or government bond sectors, offer a unique value proposition. As noted by Diamond Hill, these instruments often provide higher credit quality and yield advantages while maintaining liquidity [1]. For instance, the strategy’s portfolio is weighted toward high-grade holdings, with 60.9% rated AA and 13.3% rated A [1]. This emphasis on quality mitigates default risk, a critical consideration as rate hikes pressure lower-rated credits.

Convexity and Duration: A Tactical Edge

Convexity, a measure of a bond’s price sensitivity to interest rate changes, further underscores the strategy’s resilience. Diamond Hill’s Intermediate Bond Strategy maintains a convexity of 0.06, slightly higher than the Bloomberg index’s 0.05 [1]. This positive convexity means the fund’s price declines less sharply in rising rate environments and gains more in falling rate scenarios—a structural advantage in a world where central banks remain unpredictable.

The fund’s duration profile also reflects tactical discipline. With an effective duration of 4.02 years, the portfolio is positioned to balance income generation with interest rate risk [1]. By allocating 24.5% to the 3-5 year duration bucket and 25.5% to the 5-7 year bucket, the strategy captures yield without overexposing investors to long-term volatility [1].

Risk-Adjusted Returns: A Long-Term Perspective

While the fund underperformed the index in the immediate quarter, its long-term track record tells a different story. Over three years, the strategy has delivered a net return of 3.81%, compared to the index’s 2.36% [1]. This outperformance, adjusted for risk, highlights the compounding benefits of securitized market expertise. Even as the broader U.S. fixed income market returned 1.25% in 2024 [2], Diamond Hill’s approach has consistently navigated sector-specific challenges, such as prepayment risks in mortgages, through active management.

The Case for Securitized Markets

The inefficiencies in securitized markets are not incidental—they are systemic. Unlike corporate bonds, which trade in transparent, liquid markets, securitized products often require deeper analysis to unlock value. Diamond Hill’s focus on this niche allows it to capitalize on mispricings that broader indices cannot. For example, the fund’s yield to maturity of 5.16% [1] far exceeds the index’s typical yield, reflecting the premium available in structured credit when sourced judiciously.

Critics may argue that securitized investing is complex and opaque, but in a rising rate environment, such complexity becomes a competitive advantage. As traditional bond yields compress and duration risk rises, strategies that can harness the yield and convexity of securitized products will increasingly outperform.

Conclusion

Diamond Hill’s Intermediate Bond Strategy is not merely a fixed income fund—it is a testament to the power of specialization in an era of market fragmentation. By targeting securitized markets, maintaining disciplined convexity, and prioritizing high-quality credit, the fund has demonstrated that differentiated strategies can thrive where conventional approaches falter. For investors seeking to navigate the next chapter of the rate hiking cycle, the lesson is clear: the future of fixed income lies in strategies that challenge the index, not merely track it.

Source:
[1] Intermediate Bond Strategy - Diamond Hill,
https://www.diamond-hill.com/investment-strategies/fixed-income/intermediate-bond/separate-account/
[2] dhil-20241231,
https://www.sec.gov/Archives/edgar/data/909108/000090910825000010/dhil-20241231.htm