prevalent message being made loud and ominously clear to investors as markets
brace for the inevitable end to the ultra-loose monetary policies south of the
border and elsewhere around the world.
The warning, while important to heed, doesn’t quite add up. It’s true that
many investors will take a hit from interest rate increases down the road — and,
make no mistake, rates will rise — but the impact on the bonds, stocks, commodities and other asset classes that line
their portfolios will be far more variable. Rising rates may even have a net
positive effect on performance given the right economic backdrop.
With that in mind, here’s a quick guide on what might happen to five asset
classes when rates do rise.
Bonds are the most interest-rate sensitive asset class and generally do not
perform well during periods of rising interest rates.
Susanne Alexandor, managing director and head of wealth management at Cougar Global Investments
Ltd. in Toronto, said bonds tend to perform better when rates rise because of
inflation scares rather than strong economic growth. This is perhaps surprising,
she added, but it is because investors generally have faith in the ability of
central banks to fight high inflation.
“Corporate bonds, in particular high yield and emerging markets, offer the
best opportunities as the higher yields
offered by these lower credits help offset the capital losses,” Ms. Alexandor
Equity markets are expected to falter a bit in the initial rate-hike stages
as investors bemoan the end to accommodative monetary policies. But Colin
Cieszynski, a market analyst at CMC Markets Canada in Toronto, said any losses
would be short lived as long as the economy continues to improve.
Greg Newman, associate portfolio manager at The Newman Group in Toronto, adds
that rates on the rise for the right reasons, such as better economic growth,
are usually good for most equities. “Stocks that actually do better with rising
rates such as insurance companies, asset managers and financials
usually have an extra wind at their back,” he said
But if interest rates are rising to counteract inflation, Mr. Newman believes
the opposite would be true and many stocks would falter.
The potential for rate hikes poses a problem for investors in both private
and publicly-traded real estate investments such as REITs, especially now that
they have become so popular as a fixed-income alternative. Indeed, just the
threat of higher rates has sent a chill through the sector in recent months.
Arthur Salzer, CEO at Northland Wealth Management in Markham, Ont., said one
of the most important factors that investors need to determine is whether these
types of investments have the ability to increase their distributions over time
to offset the impact of rising rates. “Initially, however, on anticipation that
interest rates might increase, market values are likely to fall,” he said.
Commodities have been clobbered lately, but rising interest rates may
actually fix those woes.
Like stocks, Mr. Newman said the asset class should perform well in an
environment of steady economic growth. But, unlike equities, they should also
benefit in an overtly inflationary climate.
Gold is no exception, Ms. Alexandor said, noting the yellow metal is a global
inflation hedge and store of money, while jewellery demand increases the
attractiveness of gold during more normal growth scenarios. But there are some
“A substantial rise in interest rates could negatively affect gold as the
opportunity cost of holding gold as a non-income-generating asset would affect
its valuation,” she said.
There are several reasons to believe infrastructure assets, which have become
staple investments of the country’s largest pension funds, will tumble in value
once interest rates start to rise.
The main arguments are that infrastructure companies, which have assets such
as toll roads, are nothing but bond proxies and that the industry is more
susceptible to higher interest costs because it uses debt more than others.
RARE Infrastructure Ltd., a global fund manager based in Australia, doesn’t
agree, however, and believes the outcome is far more binary. If interest rates
rise over the next six to 12 months because inflation expectations increase, it
believes infrastructure as an asset class will benefit and the portfolio should
But, it adds, if interest rates are rising in the same time period even after
accounting for inflation, “the value of most assets will be negatively