Jamie Clark

How we are playing the interest rate inflexion

Jamie Clark

Earlier this month, following the Bank of England’s promise of a rate hike after a 10 year wait, I argued that higher rates should be no surprise in a UK economy at virtual full employment. I also suggested that our funds – the Liontrust Macro Equity Income Fund and the Liontrust Macro UK Growth Fund – are well positioned to exploit this inflection in UK rates.

Stephen and I run a Macro-Thematic process. This means we look for powerful, top-level trends that have the potential to drive company earnings and dividend growth. Presently, we seem to be finding some of the best thematic opportunities in companies that might be characterised as ‘value’.

This is not to suggest that we’ve ditched our thematic method and been born-again as the deep value progeny of Ben Graham. It simply means that present circumstances lend themselves to a value tilt.

Why is this the case? Currently, value looks cheap relative to both its own history and ‘quality’, a bracket which is often used to cover companies with high return-on-equity (RoE). More pertinently in a world of rising interest rates, empirical evidence suggest that the success of value is tied to rising inflation expectations and bond yields. Intuitively, higher rates imply economic growth and value stocks tend to be more sensitive to the economic cycle.

European value performance vs bond yields

European value performance vs bond yields

Source: IBES, Factset, Bernstein – “Global Quantitative Strategy: Styles for Autumn” 13 September 2017

Here are three Macro-Themes that we believe will benefit from higher rates:

Population Ageing

This theme is mainly comprised of UK life Insurers. Thematically, we think earnings and dividend progression will flow from population ageing, unmanageable corporate and government pension liabilities and the accompanying need for individuals to make adequate retirement provision.

But, like many financial companies, UK lifes have struggled with low rates. Low rates increase the value of balance sheet liabilities, especially on products like annuities that pay guaranteed rates. Higher yields mitigate such pressures, give greater visibility of earnings and should drive a sector re-rating.

(Fund holdings include Legal & General, Aviva, Phoenix Group, Chesnara, Prudential plc and Prudential Inc.)

Data Growth

The telco constituency of the Data Growth theme offers another instance of the process’ bias to higher rates. Dismissed by many as bond-proxies and vulnerable to rising yields, we’d suggest that our telco holdings are better seen as defensive value. In fact, a legacy of wasteful M&A, capex obligations and regulatory duress, means telcos have demonstrated scant correlation with bond prices. This has left them keenly priced vis a vis other defensive industries (tobaccos, staples etc) and suggests they represent an attractive alternative.

We’d argue that rising rates will force investors to reappraise how much they’re prepared to pay for defensive earnings and that telcos, complete with the thematic attractions of data growth and monetisation, are especially well placed to benefit. 

(Fund holdings include BT, Vodafone, AT&T and Verizon)

Infrastructure Spending

Our Infrastructure Spending theme was initiated in response to the multi-decade fall in rates, the suggestion of economic stagnation this carried and the call for fiscal solutions. Growth and higher rates don’t disprove this, but serve to hasten what’s termed the fiscal flip; a renewed emphasis on fiscal policy as monetary policy becomes tighter.

(Fund holdings include Kier, Barratt Developments, Taylor Wimpey, Persimmon, Marshalls and Rio Tinto)

Disclaimer:

• This content contains information and analysis that is believed to be accurate at the date of publication but is subject to change without notice. Whilst care has been taken in compiling this content, no representation or warranty, express or implied, is made by Liontrust as to its accuracy or completeness. Some parts/sections of this content may been compiled from external sources. Whilst these sources are believed to be reliable, the information has not been independently verified and therefore no representation is made as to its accuracy or completeness. • It should not be copied, faxed, reproduced, divulged or distributed, in whole or in part, without the express written consent of Liontrust. • Past performance is not a guide to future performance. Do remember that the value of an investment and the income generated from them can fall as well as rise and is not guaranteed, therefore, you may not get back the amount originally invested and potentially risk total loss of capital. The issue of units/shares in Liontrust Funds may be subject to an initial charge, which will have an impact on the realisable value of the investment, particularly in the short term. Investments should always be considered as long term. • Any decision to invest should be always based on the final Prospectus and Key Investor Information Documents (KIIDs) and you should take independent legal advice if necessary. These documents contain important information which should be read before investing in any fund and they can be obtained, free of charge, here.

• Investment in Funds managed by the Macro Thematic team involves foreign currencies and may be subject to fluctuations in value due to movements in exchange rates. The Funds' expenses are charged to capital. This has the effect of increasing dividends while constraining capital appreciation. The performance of the Liontrust GF Macro Equity Income Fund may differ from the performance of the Liontrust Macro Equity Income Fund and is likely to be lower than its corresponding Master Fund due to additional fees and expenses.

Wednesday, September 27, 2017, 3:33 PM