Brace your­self

In­ter­est rates will rise but you can still get real re­turns in eq­ui­ties

Finweek English Edition - - MONEY CLINIC - SHAUN HAR­RIS shaunhar­ris@ya­

SURE AS THE SUN WILL RISE, so will in­ter­est rates. Climb­ing in­fla­tion is putting pres­sure on the SA Re­serve Bank to in­crease rates. It’s hap­pen­ing world­wide, of­fer­ing op­por­tu­ni­ties in some coun­tries – es­pe­cially emerg­ing mar­kets. But in­vest­ment op­por­tu­ni­ties will come with risks. The nascent re­cov­ery in South Africa could stall, the big­gest threat prob­a­bly be­ing pol­i­tics.

Look­ing at off­shore op­por­tu­ni­ties in a ris­ing in­ter­est rates en­vi­ron­ment, Michael Hasen­stab, a port­fo­lio man­ager and codi­rec­tor of in­ter­na­tional bonds at Franklin Tem­ple­ton In­vest­ments, sees good op­por­tu­ni­ties in many economies out­side the G3, namely the United States, the Eu­ro­zone and Ja­pan. “Most emerg­ing economies and many de­vel­oped ones were not overly re­liant on lever­age be­fore the cri­sis. Con­se­quently, they’ve been well po­si­tioned to re­cover quickly with rel­a­tively low lev­els of in­debt­ed­ness in their con­sumer, fi­nan­cial, cor­po­rate or gov­ern­ment sec­tors. We think ro­bust growth, higher in­ter­est rates and good credit con­di­tions should con­trib­ute to strong cap­i­tal in­flows and cur­rency per­for­mance in those mar­kets.”

Paul Ste­wart, MD of Plexus As­set Man­age­ment, says the main concern for South African in­vestors isn’t whether there will be a rate hike but rather when and by how much. Asked for his fore­cast, he says by 0,5% by year-end 2011. “I think the to­tal quan­tum of rate hikes over the next two to two-and-a-half years will be 2% to 2,5%.”

What does that mean for in­vestors? Fo­cus­ing on emerg­ing mar­kets, Hasen­stab says the com­bi­na­tion of good fun­da­men­tals out­side the G3 and ex­ces­sive liq­uid­ity in the G3 should con­tinue to pro­vide cap­i­tal to emerg­ing mar­kets, which should con­tinue to boost in­vest­ment and growth. That was seen over the past month as for­eign in­vestors be­came big buy­ers of South African bonds. “The chal­lenge is man­ag­ing that growth and these cap­i­tal flows to avoid as­set price bub­bles or con­sumer price in­fla­tion,” Hasen­stab says.

Coun­tries where he’s tak­ing in­vest­ment op­por­tu­ni­ties in­clude Aus­tralia, due to its con­ser­va­tive fis­cal pol­icy. He’s also in­vest­ing in Asia (ex­clud­ing Ja­pan) and se­lect coun­tries in Latin Amer­ica. “Coun­tries in Scan­di­navia and cen­tral Europe are at­trac­tive to us due to good poli­cies and ben­e­fits from in­te­gra­tion with strong Ger­man ex­port per­for­mance,” he says.

Plexus con­ducted a study com­par­ing the per­for­mance over 11 years of the FTSE/ JSE re­sources, in­dus­trial and fi­nan­cial in­dices dur­ing dif­fer­ent in­ter­est rate cy­cles. The cy­cles were di­vided into down, flat and ris­ing in­ter­est rates. “The neg­a­tive ef­fect on fi­nan­cials in an up cy­cle can be ex­plained by the higher debt bur­den on bor­row­ers from banks, re­sult­ing in fewer loans and more bad debts, while bank mar­gins re­main un­changed,” Ste­wart says.

With in­fla­tion and, in turn, in­ter­est rates in­creases, the op­por­tu­nity to ob­tain real re­turns be­comes in­creas­ingly dif­fi­cult. “Bonds and cash gen­er­ally don’t pro­vide pos­i­tive real re­turns in an in­creas­ing in­ter­est rate en­vi­ron­ment.” Ste­wart is there­fore look­ing at eq­ui­ties, say­ing real re­turns can be ob­tained in a ris­ing in­ter­est rate cy­cle – even when it’s neg­a­tive for other as­set classes.

But what shares is he in­vest­ing in as rates be­gin to rise? “In re­sources its Lonmin, Mondi, ArcelorMit­tal and BHP Bil­li­ton. In the in­dus­trial sec­tor we like Pick n Pay, JD Group, Mass­mart, Vo­da­com and Telkom. Fi­nan­cials in­clude Santam, Lib­erty Hold­ings, Dis­cov­ery and Stan­dard Bank.”

Telkom is the in­ter­est­ing choice in the port­fo­lio. Ste­wart says with the prob­lems it’s go­ing through it’s look­ing like an unattrac­tive in­vest­ment. “Which is pre­cisely the time to buy it.”


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