Ways investors can take advantage of rising interest rates

A decade on from the global financial crisis central banks, regulators and policy makers have done what it takes to change and maintain a stable financial system.

Article updated: 27 November 2017 10:00am Author: Sheridan Admans

Economic growth has stabilised and has tracked a low but steady momentum. Some inflation is now coming back into the system leading to central banks either raising rates or indicating or undertaking monetary tighten. As economies start the slow shift back to more normal market conditions, what can investors do to profit from these dynamics?

Backdrop to economic growth

Global economic growth is expected to maintain a steady pace in 2018 according to data produced by the International Monetary Fund (IMF), indicating it anticipated global Gross Domestic Product (GDP) to grow at 3.8%. Growth has been supported by central banks putting in place mechanisms that have lowered the borrowing rate, helping to maintain a flow of capital in the financial system resulting in an improved employment and investment backdrop.

Interest rates have been rising in the US at a glacial pace and it is expected that they will see one further hike in December with the trend continuing through 2018. It is also widely expected that the European Central Bank (ECB) will reduce money supply further in 2018, while the Bank of Japan (BoJ) are signalling no change for now and the UK may see another small rise.

These slow changes to central banks policies on rates should benefit the profit margins of financial institutions ahead. Financials should also benefit from spending on infrastructure, as now being muted by some governments, low corporate taxes, rising loan demand and wage growth.

Investments that should be beneficiaries of rising rates

Rising interest rates affect assets and parts of the market in varying ways. Assets that benefits from a rise are financials. Financials tend to consist of banks, life and non-insurance, exchanges, property and asset managers; they tend to perform well during strong business cycles supporting returns consistent with a healthy economy.

The insurance sector is a direct beneficiary of rising interest rates because they derive their investment income from investing their premiums in government and corporate bonds. Rising rates enable insurance companies to invest their premiums at higher yields.

In simple terms banks’ margins benefit from rising rates, as the yield on cash in accounts goes straight to the profit line and improves margins on lending rates.

It can’t be ignored that rising rates will have a negative impact on the fixed borrowing cost of property ownership. However, a rising rate environment indicates the economy is growing; jobs growth, inflation targets are being met or exceeded and wages are on the rise. This should see property owners demanding higher rents and higher sale prices.

Fixed income or bond investors tend to lose out when rates rise as the value of the bonds already held fall. However, there are some bonds out there that should benefit those that have a preference for the asset class. Convertible bonds should also outperform in a rising rate environment, as they tend to have little long-term correlation to rate rises. Convertible bonds tend to perform more like equities when markets are rising and more like bonds when they are in decline.

Financial crisis and a question of trust

The stock market crash of 2008 left investors wary of the financial sector, banks in particular. Today, those same financial institutions that had to be bailed out by the tax payer look very different, as the regulator and legislation demanded more financial accountability and transparency from them. This has been key. Without banks undertaking the measures imposed on them it would have been impossible to achieve the confidence it needs to survive. And without such changes the global path of economic growth we are witnessing would not have been achievable.

While there is still work to do in the financial system banks have much stronger balance sheets than they once did and much deeper capital cushions, which have helped to reduce the risk of another financial crisis.

Investment ideas that should benefit from rising rates:

Jupiter Financials

Financial institutions which should be able to make more from rising rates in the years ahead with the expectation that central banks will continue to pursue a policy of rate rises and the support from the improving health of the global economy.

Polar Capital Convertible

Holder of a convertible an investor has the benefit of receiving a fixed income amount on the loan until maturity but with the added benefit of converting it to equity to potentially receive higher dividend income should the company be performing well. 

Polar Capital Global Insurance

For those investors seeking an opportunity to potentially invest in the global insurance market, then this fund may well provide appropriate rewards over the medium to longer term. This is the only European fund dedicated to investing in the global insurance industry.

First State Global Property Securities

Real estate markets are supported by attractively priced debt and the health of equity markets. This has supported momentum in rental growth and improved earnings in the asset class. 

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All information given including prices, yields and our opinion is correct at the time of publication. Our opinions on investments can change at any time and for our latest view please go to www.share.com. To understand how our Investment research team arrive at their views please read our Investment Research Policy.

Sheridan Admans portrait photo
Sheridan Admans

Investment Manager

Sheridan co-manages our TC Share Centre Multi-manager funds and heads our team of research analysts. He is a chartered wealth manager and qualified financial adviser, and his qualifications include the Securities & Investment Institute (SII) Diploma and an MBA in investment analysis.