With interest rates at historic lows and no place to go but up, it behooves investors to have a strategy in place ahead of a rate hike cycle that is likely to begin this year.
“This is definitely a time to start thinking about it, because most investors will be challenged in a rising-rate environment,” said John Eckel, president of Pinnacle Investment Management Inc., which has $100 million in assets under management.
Typically, technology and health care stocks outperform amid rising interest rates, while financials and materials trail behind.
Indeed, an analysis of the 13 rising-rate environments over the past 64 years found that the tech sector of the S&P 500 gained an average of 20% during the 12-month period following the first rate hike of each cycle. Health care stocks, meanwhile, represented the second-best-performing sector, with a 13% average gain.
The worst-performing sectors were financials at 4% and materials at 3%.
This compares with an average gain of 6.2% by the S&P 500 over the same 13 rising-rate cycles.
“Investors will want to be ahead of the curve, because the markets are forward-looking, and they tend to factor in the expectations,” said Todd Rosenbluth, an equity analyst with Standard & Poor's Financial Services LLC.
In analyzing each of the Federal Reserve Board's monetary tightening policies between January 1946 and the most recent rate hike, in July 2006, Mr. Rosenbluth found that there are ways to make the most of rising interest rates.
He identified three examples of mutual funds that, according to the most recent regulatory filings, should benefit in a rising-rate environment.
The Calvert Social Investment Equity Fund (CSIEX), Laudus Growth Investors U.S. Large Cap Growth Fund (LGILX) and the Sit Large Cap Growth Fund (SNIGX) each have more than 40% weightings in a combination of technology and health care stocks.
The S&P research also ran both quantitative and qualitative screens on each fund's portfolio and identified examples of stocks that perform strongly in a rising-rate environment.
In the Calvert fund, from Calvert Asset Management Co. Inc., the examples from the most recent filing with the Securities and Exchange Commission were Novartis AG (NVS), Stryker Corp. (SYK) and Qualcomm Inc. (QCOM).
In the Laudus fund, from The Laudus Group of Funds, there were Cisco Systems Inc. (CSCO) and Allergan Inc. (AGN).
In the Sit fund, from Sit Investment Associates Inc., the two examples were International Business Machines Corp. (IBM) and Oracle Corp. (ORCL).
Mr. Rosenbluth acknowledged that portfolio managers can adjust investment allocations based on the direction of interest rates, but he added that a lot of funds are restricted by their mandates from moving too far in or out of some sectors.
“Certainly, this might be a good exercise to redo once the Fed starts actually raising rates,” he said. “But for now, it starts to answer questions that investors have about how rising rates will affect their portfolios.”
Mr. Rosenbluth's research also considered examples of mutual funds that were heavily weighted at year-end in financial- and material-sector stocks.
The Morgan Stanley Focus Growth Fund (AMOAX) had a 19% weighting in financials and 6% in materials, including Monsanto Co. (MON) among its top 10 holdings.
By comparison, the S&P 500 had a 15% weighting in financials and 4% in materials.
The Legg Mason ClearBridge Capital Fund (SCCAX), offered by Legg Mason Global Asset Management, did not hold any materials stocks at year-end, but it had an 18% weighting in financials, including Invesco Ltd. (IVZ) and The
Charles Schwab Corp. (SCHW).
There is also the extreme example of the Burnham Financial Industries Fund (BURFX), which by design had more than 90% of its assets allocated to financial stocks.
Anton Schutz, who manages the $160 million Burnham fund for Burnham Asset Management Corp., is shrugging off the challenge of rising interest rates as just another part of his job.
“You have to consider where rates might be moving — on the long or short end of the market — and you have to also look at why rates are moving,” he said. “I think the Fed will need to see a stronger economy and four to six months of strong employment numbers before it starts raising rates.”
With the Fed holding the over-night rate at less than 25 basis points since January 2009, it is obvious that rates can move in only one direction. However, forecasting when exactly that might happen is more art than science.
“The Fed almost never moves rates until the market moves them first,” said Tom Samuels, a money manager at Palantir Capital Management Ltd., which is a long-short investment firm with $100 million in assets.
And one of the major market forces that is being watched by analysts is the growing levels of debt being issued by the federal government.
“Unless [President Barack] Obama puts out some kind of plan to deal with the deficit, the bond market will force up rates on government debt,” said Wyatt Crumpler, vice president of asset management at American Beacon Advisors Inc., which has $41 billion under management.
Questions, observations, stock tips? E-mail Jeff Benjamin at [email protected].
