21st December 2016 by Darius McDermott
Darius McDermott, managing director, Chelsea Financial Services, considers the impact on the rise in US rates.
I spent a lot of time last week talking about the US interest rate rise with industry peers. At a Christmas dinner on the weekend, however, a family friend asked me one simple question: should I change my portfolio? The yes/no answer will depend on your personal investments, but here are a few key things to think about.
First up, I would caution investors against any knee-jerk selling or buying reactions. At times like these, market ‘noise’—as we call the volume of news and commentary that generally surrounds such ‘big events’ in the finance world—tends to rise and suddenly every man and his dog is an expert with a crystal ball. Because America is such a powerful economy, its actions can impact countries and assets around the world.
If you invest to achieve long-term goals though (which is generally the recommended approach), keep these goals in mind as you review your portfolio. Has the interest rate rise really affected the outlook for your investments over your return time frame?
For example, if you bought US equities to benefit from the potential strong earnings growth of some of the best companies in the world over 10 years or more, your hypothesis should not have fundamentally shifted. Or, you may have seen some headlines suggesting the US rate rise could be ‘bad’ for emerging markets, who may now find it harder to pay off their US dollar debts. This could be true, but again, emerging market equities are a long-term play and many of these nations’ core characteristics, such as young populations and growing middle classes, will remain attractive.
That said, it is always useful to have an idea of what you could expect to see in the coming months or year. Indeed, this may help you to feel comfortable with shorter-term fluctuations in the value of your investments.
Something to be aware of is the rise in the US dollar. Since the rate announcement last week, it has strengthened against nearly all major currencies. As a UK investor, if you already own US equities, this is good news. It means your returns, when converted back into sterling, will now be worth more. This affect will be compounded this year due to the fall in the pound following the Brexit vote. If you’re thinking about buying, however, it does make US equities even more expensive. The market is already trading at record highs and, put simply, it’s much harder to make money from something when you’ve already paid quite a lot for it.
This also leads to a question of investing ‘style’ generally, which we often talk about in terms of value or growth. (My colleague, senior research analyst James Yardley, wrote a very good piece explaining the key differences between these two styles earlier this year.) Prior to this year, quality growth style has been very much in favour, which means larger companies in defensive industries have done well. You sometimes hear these companies referred to as ‘bond proxy’ stocks, because they have attracted investors seeking relatively stable income in a low interest rate world.
Rising rates, on the other hand, suggest a period of good economic growth, during which cyclical industries and cheap, value stocks tend to do best. The US has suggested it may raise rates three more times in 2017 and the UK could do so at least once, particularly if inflation here really starts to pick up with a falling pound. In 2016, we have already seen a bit of a rotation back towards ‘value’ investing and these rate movements could be a catalyst for further value outperformance over the next year.
So while I don’t necessarily advocate making any radical changes to a globally diversified portfolio in the wake of the US interest rate decision, it may be worth at least reviewing your holdings to see if you have a particularly strong weighting towards either value or growth style investments.
If you do want to add a bit of exposure to value, one global fund I like is M&G Global Dividend. While its style is not as explicitly ‘value’ as others, manager Stuart Rhodes does pay a lot of attention to valuation (not overpaying) and, most importantly, he is willing to be a bit different to your standard global equity income fund. This means he won’t just be holding the aforementioned bond proxies. Stuart looks for growing dividends, as opposed to simply the highest yields, so he may buy more medium-sized companies that are less held by other managers.
In the UK, Jupiter UK Special Situations offers a reasonably diversified large and medium company portfolio with a value-driven strategy. Manager Ben Whitmore has a bold approach, in that he doesn’t try to predict the future at all in terms of earnings expectations, he just buys what he sees as solid companies at cheap prices – the epitome of value, in some ways. Or Schroder Recovery is a more aggressive value fund, whose managers’ strong stock picking skills could see the fund do well if 2017 macroeconomic conditions also fall in their favour.
Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. Darius’s views are his own and do not constitute financial advice.