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)


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Wednesday, September 27, 2017, 9:18 AM