Financials, insurance and high yield bonds are three areas that should benefit from a rising interest rate environment, according to market commentators.
Rising interest rates have been a major discussion point over the past year as the Federal Reserve began its rate hike cycle and comments by European Central Bank president Mario Draghi suggesting the withdrawal of quantitative easing policies and the rate hikes from the ultra-low rate environment that has defined his tenure.
Even in the UK, Mark Carney, governor of the Bank of England, has mooted the idea of raising interest rates that he cut last year following the result of the EU referendum.
With many commentators suggesting that rising interest rates could be one of the main catalysts for changes in the market, FE Trustnet asked which funds are in the best position to succeed.
One area set to benefit is funds with a financials sector focus, with banks in particular likely to improve greatly with interest rates rising, according to The Share Centre’s Sheridan Admans.
“Financial institutions should be able to make more from loans in the years ahead with the expectation that central banks will pursue a policy of rate rises,” the investment research manager said.
Banks that slashed dividends and cut buybacks in the wake of the financial crisis have in recent years regained confidence to re-instate dividend policies once more.
However, it is not just the banks that should benefit but the wider financials sector in general should do well, Admans noted.
“Insurance companies could be in a position to improve their investment returns on their bond portfolios and exchanges, all the while brokers and asset managers should benefit from improved sentiment in the financial system and the opportunities thrown up from a more stable economic backdrop,” he said.
As such the research manager suggests the £48m Jupiter International Financials run by FE Alpha Manager Guy de Blonay, who ran the fund alongside Robert Mumby from 2011 before taking sole charge in 2015.
The fund has returned 127.62 per cent over the last five years, 16.37 percentage points ahead of the MSCI ACWI/Financials benchmark index.
Performance of fund vs benchmark over 5yrs
Source: FE Analytics
The fund focuses on international equities in the financials sector and is 72.7 per cent invested in banks, 23.7 per cent in financial services and 10.2 per cent in life insurance firms.
It is 47.9 per cent weighted to Europe with 29.6 per cent in the US and 22.4 per cent in Asia ex Japan. The fund has a yield of 1.2 per cent and a clean ongoing charges figure of 1.1 per cent.
Staying with financials-based funds, Premier Asset Management multi-asset manager Simon Evan-Cook suggests insurance is the way for investors to go.
“If rates rise gently, suggesting a solid, measured economic recovery, then most equities will benefit - with perhaps any good value fund likely to benefit more than a growth fund,” he noted.
“However, if it’s a less-benign scenario with inflation and/or rates rising rapidly despite weak economic growth, it’s much harder to find a fund that will protect you, as not many assets will benefit from such a scenario.”
One fund that should benefit from the first scenario is the five crown-rated, £886m Polar Capital Global Insurance fund run by Alec Foster and FE Alpha Manager Nick Martin.
The fund typically invests in 30-35 holdings in the insurance sector with 47 per cent invested in the US and 25.8 per cent in Bermuda and 10.2 per cent in the UK.
Over 10 years the fund has returned 235.04 per cent, more than double the returns of the MSCI World/Insurance index’s 104.22 per cent and Evan-Cook said there two reasons it should continue its strong performance in a rising interest rate environment.
Performance of fund vs benchmark over 10yrs
Source: FE Analytics
“One of those is that it’s been able to perform well in recent market conditions, helped by its managers’ focus on well-run, non-life insurance companies: These have been able to grow their businesses strongly despite tepid economic growth.
“But another reason we like it is that insurance companies’ valuations are lower currently because interest rates are depressed.
“Insurance companies are large holders of bonds, so when bond rates drop, so do their returns. Rising rates would actually be beneficial to the businesses in this portfolio, and may lead to them being positively re-rated.”
Polar Global Insurance has an OCF of 0.91 per cent.
The final fund that should benefit from rising interest rates is the M&G Global Floating Rate High Yield fund, according to Square Mile head of research Victoria Hasler.
The fund run by FE Alpha Manager James Tomlins and deputy manager Stefan Isaacs since its launch in 2014 has struggled since inception, sitting in the bottom quartile of the IA Sterling High Yield fund.
Performance of fund vs sector since launch
Source: FE Analytics
“This fund invests in high yield bonds whose coupons are variable and linked to the underlying Libor rate in the currency in which they are issued, usually expressed as Libor plus a specified margin,” Hasler explained.
“The income on these bonds (and therefore the fund) should thus increase as interest rates (and therefore Libor rates) rise, and in this way the fund is likely to benefit from rising interest rates and provide protection for investors.”
Additionally, while the fund does not offer explicit inflation protection, the floating rate nature inherent in the securities in which the fund invests, means that their coupons should rise as interest rates rise.
“This means that the fund may also provide a level of protection against inflationary forces in the long term as suggested by the historical relationship between inflation and interest rates (i.e. as inflation rises interest rates tend to rise). This is by no means guaranteed, however,” she said.
The £3.74bn fund has a yield of 3.38 per cent and an OCF of 0.84 per cent.
In an upcoming article later this week FE Trustnet will also look at the funds that should benefit from rising inflation rate environment.