Before the recent spike in Treasury yields, investors were in widespread agreement that long-term bonds, especially long-term Treasuries, would be particularly hard-hit in a rising-rate environment. Sure enough, long-term Treasuries have gotten socked during the past few months as yields have jumped up. The typical long-term Treasury fund in Morningstar's database dropped about 13% from the time yields began rising in early May through July 5, when yields topped out (at least for now).
Yet rising-rate pain hasn't been limited to long-term Treasuries. A host of disparate categories, from emerging markets to REITs, have experienced large losses recently.
Does that mean you should scrub your portfolio of securities you perceive to berate-sensitive? Not necessarily, as rates can turn on a dime. Just during the past week, Treasury yields have dropped down again, and the bonds have rallied as Federal Reserve chairman Ben Bernanke aimed to reassure investors that the Fed won't be tapering its bond-buying program imminently. Moreover, there's notelling that the crop of investments that fared poorly in the recent rate uptick will necessarily struggle in the next one. Additional factors--from slowing economic growth to an appreciating dollar--might have played as much a role in their recent troubles as rising rates.
But if you found your portfolio rattled more than you might have expected amid the market's so-called recent taper tantrum, that should serve as an impetus to check on what performed poorly and why. Here's an overview of some of the securities that were hardest-hit during the recent yield spike, along with why they struggled. In certain categories, the recent performance struggles were driven by additional factors--not just rate increases--so these categories' slumps aren't necessarily a harbinger of bad performance the next time rates rise.
Treasury Inflation-Protected Securities
Loss from May 1 to July 5: -7.86%
Why They Dropped: TIPS have suffered from a bad convergence. The asset class has always been quite rate-sensitive, and coming into the recent rate spike, most TIPS funds sported the bad combination of fairly long durations [a measure of interest-rate sensitivity] of 6 to 8 years or more and meager yields. But perhaps an even bigger strike against TIPS has been the fact that inflation is currently quite tame, in large part because of slowing economic growth overseas. That, in turn, has reduced demand for securities with built-in inflation protection, damping TIPS' prices.
Takeaway: TIPS remain the most direct way to hedge against inflation, and therefore they can serve a valuable role in a portfolio. But their recent weakness underscores their vulnerabilities in certain environments and the importance of having an appropriate time horizon for owning them. Because their rate sensitivity is likely here to stay, a core TIPS fund like 
Harbor Real Return (HARRX) or Vanguard Inflation-Protected Securities (VIPSX) is best used in the intermediate-term portion of a portfolio--that is, for time horizons of at least five years. (Vanguard Short-Term Inflation-Protected Securities (VTIPX), a new Vanguard fund, may be appropriate for those in need of a shorter-term inflation hedge.) It's also worth noting that working investors who are earning periodic cost-of-living adjustments need relatively less inflation protection than retired investors who are spending their portfolios. But some retirees may not need substantial TIPS exposure, particularly if Social Security and/or an inflation-adjusted pension or annuity is fulfilling a higher share of their income needs.
Emerging-Markets Bonds
Loss from May 1 to July 5: -9.58%
Why They Dropped: Emerging-markets bonds have suffered some of the steepest losses during the recent rate increase, with emerging-markets bonds denominated in local currencies faring worst of all. (Diversified funds such as PIMCO Total Return (PTTRX) have also struggled because of their emerging-markets stakes, as discussed in this video.) A few key factors are behind the recent swoon. First, rising Treasury yields make risk-taking in emerging-markets bonds seem less attractive. Why take on the extra risk in an emerging-markets bond for a yield that's only a few percentage points higher than what you can get in Treasuries or high-quality U.S. corporate bonds? Moreover, key emerging-markets currencies--including the Indian rupee--have plunged relative to the dollar and in the process have dragged down bonds denominated in those currencies.
Takeaway: Investors had arguably become complacent about the risks in emerging markets and other risky bond types--including the locally denominated debt--enticed by their higher yields. The recent tremors underscore the bonds' vulnerabilities in certain environments. It's not necessarily time to jettison the bonds--in fact, some experts say that the rout has created opportunities. But if you have an emerging-markets bond fund in your portfolio, it's worth checking up on its strategy and positioning. The recent performance weakness also underscores that non-dollar-denominated bonds introduce a wild card--foreign currency fluctuations--into the portion of a portfolio that most investors look to for ballast. Morningstar's Lifetime Allocation Indexes call for just a small share of a portfolio to be staked in foreign bonds (not just emerging markets). Moreover, the indexes' weightings in foreign stocks and bonds taper off as an investor grows closer to retirement.
Emerging-Markets Equities
Loss from May 1 to July 5: -10.09%
Why They Dropped: Like emerging-markets bonds, emerging-markets stocks have suffered for a variety of reasons--not just rising rates. Slowing growth in key markets, especially China and India, has depressed share prices in a number of emerging markets. Appreciation in the dollar versus many foreign currencies has also had a hand in the securities' slump.
Takeaway: Although emerging markets have fallen because of concerns about slowing growth, cheap valuations tend to be a better predictor of market performance than gross domestic product growth, as discussed in this Vanguard paper. That means periods of macroeconomic pessimism, like what emerging markets are experiencing right now, can spell buying opportunities. Delegating your emerging-markets stake to value-minded foreign-stock manager with a history of playing emerging markets to good effect is one way to approach the situation;
Dodge & Cox International Stock (DODFX) is a prominent example.
Utilities
Loss from May 1 to July 5: -6.16%
Why They Dropped: As bond yields have shriveled during the past several years, investors have been flocking to dividend-rich stocks such as utilities. In many cases, doing so has enabled them to pick up commensurate or even higher yields than they could earn in bonds, along with some growth potential to boot. Like other income-producing stocks, however, utilities often suffer by comparison when bond yields rise. Additionally, utilities enjoyed a stellar first quarter and were priced for perfection coming into the recent rate increase, according to Morningstar analysts' price/fair value ratios.
Takeaway: Despite the recent performance weakness, the average utilities stock in Morningstar's equity analysts' coverage universe is about 5% overvalued currently, even though the sector got cheaper back in late June. It's also worth remembering that utilities take up only a small share of the total U.S. market--roughly 3%, as of last count. Use Morningstar's Instant X-Ray tool to check your weighting in the sector and be mindful of the risks if your stake in the sector is substantially higher than that. In addition to so-so valuations, utilities are apt to remain rate-sensitive for the foreseeable future.
REITs
Loss from May 1 to July 5: -7.37%
Why They Dropped: REITs' recent decline has a lot in common with the story on utilities. Although REIT yields are typically higher than what you'd earn on a high-quality bond, they suffer when bond yields rise. Moreover, REIT prices looked precarious coming into the sell-off; during the past five years, stocks in the sector have looked especially overvalued to Morningstar equity analysts while yields have declined. Global real estate securities have faced the double whammy of rising U.S. bond yields and a rising dollar, with the average fund in the group dropping 9.4% from early May through early July.
Takeaway: Although the average REIT looked cheaper to Morningstar's equity analyst team a few weeks ago, it's been off to the races for the sector lately. That means that the average stock in our coverage universe is now trading above its fair value. Here again, it pays to check on your exposure relative to a total U.S. market index, which currently includes a 3.6% allocation to REITs. If you have a small-value fund in your portfolio, it's a good bet you already have plenty of REIT exposure; the average fund in the group stakes 7% of its assets in the sector.
Christine Benz is Morningstar's director of personal finance.
