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On the radar

Interest rates: The slow return to normality

Interest rates: The slow return to normality

Lynn Strongin Dodds
Friday 15th December 2017

Interest rates are rising, inflation is climbing and it is goodbye to QE. Lynn Strongin Dodds looks at what impact these changes will have on portfolios.

“The shrinking of central bank balance sheets and the end of the extraordinary monetary policy means asset prices will no longer be based on liquidity but will be driven by fundamentals.”

Tom Wells, Aviva Investors

After bumping along the bottom for years, interest rates are starting to rise while central banks are pulling the plug on their abundant stimulus programmes. Although the moves are gradual and well flagged, experts are advising investors to review their portfolios and prepare for this slow return to normalcy.

Governments may be moving at their own pace, but as Tom Wells, a fund manager in Aviva Investor’s multi-asset team, notes: the withdrawal may be slow but the direction of travel is one way and QE is not increasing. “In our view, the shrinking of central bank balance sheets and the end of the extraordinary monetary policy means asset prices will no longer be based on liquidity but will be driven by fundamentals.”

Asset allocation, of course, depends on an institutional investor’s particular objectives, funding levels and requirements but pockets of opportunities may be harder to find going forward. “The high valuations in nearly all asset classes, the persisting economic cycle, rising inflation and less expansionary-minded central banks now make us less optimistic about the period after 2018,” says Ivo Kuiper, head of Kempen Capital Management’s asset allocation team.

“Yet sentiment is very positive, both in an economic sense and on the financial markets, and we therefore expect the equity rally to persist in the short term,” he adds. “Economic confidence indicators are high, corporate earnings continue to rise and money will remain cheap for the time being,” Kuiper says. “The expected rise in inflation means that we are slowly becoming more positive about real estate, commodities and other inflation hedges.”


Ron Temple, co-head of multi-asset and head of US equity at Lazard Asset Management, also believes that global equities are more attractive than fixed income assets thanks to robust earnings growth. “Our strong belief is that security selection will be critical to generating returns in the years’ ahead, given the risk of drawdowns on the back of unforeseen events and as different countries and companies deliver varying degrees of growth,” he says.

Temple singled out Japan in particular because the MSCI Japan Index is the “only major market index that is not trading at a substantial PE premium to an historical average, with the index trading at a premium of 0.3 times earnings relative to its 10-year median,” he adds.

“We believe Japanese companies still have substantial room to improve their returns as the macroeconomic backdrop has improved and the corporate governance reforms of recent years have better positioned many companies for future profit growth.”

Columbia Threadneedle Investments head of multi-asset Toby Nangle is also bullish on Japanese as well as European equities believing that they are well-placed to benefit from a global and synchronised cyclical upswing. “Both markets should see reflationary forces translate into higher levels of profitability for shareholders, and it is these forces that are prompting higher interest rates in the US where there appears to be little economic slack,” he says.

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