Positioning Portfolios for a Rising Rate Environment
The Fed’s ZIRP (Zero Interest Rate Policies) led to a profound shift towards high-dividend stocks, MLPs (Master Limited Partnerships), REITs (Real Estate Investment Trusts) and bonds. That trend was clearly in effect until recently when Treasury bond coupon rates hit generational lows.
Long-term rates bottomed out in 2012, trended somewhat sideways until May 2013, but have been spiking sharply higher since. Investing for the now-completed falling interest rate cycle will leave investors badly positioned going forward.
Research outfit Morningstar put out a nice display of relevant information on what classes of stocks do best in a rising rate world. Their numbers, dating all the way back to 1952, suggest an almost 180-degree change in focus to stay ahead of the curve.
During periods of expanding rates, shares of non-dividend payers trounced the overall market averages while the highest-paying 30% of companies showed negative returns.
Large-cap shares that outperformed small-caps when rates were declining sucked wind during periods when interest rates were climbing. Not surprisingly, the highest yielding groups were negatively correlated with market action when rates rose while also showing decreased volatility.
Low-dividend and no-dividend stocks made better gains, and with more pronounced moves, as stock market history buffs repositioned into the right shares for the new reality.
First mover advantage can be huge if you want to take full advantage of the shift. Most investors simply fight the "last war" by continuing to do what had worked well in the recent past.
Now that we’re likely into a sustained higher rate trend you need to change your way of thinking if you want to beat the market.
Those who stayed too long in REITs, bonds and staid utilities have already felt the pain of not recognizing a sea change as it unfolded. Expecting a repeat performance of the QE-induced ZIRP period will probably keep you waiting a long time while sitting in the wrong sectors.
This is the time to own low/no debt companies that are unburdened by large dividend payments. Those managements will have the flexibility to make acquisitions, buy back shares or expand their businesses to create true shareholder value.
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