Impact of future rate hikes will be minor

Rising interest rates are expected to have little impact on the asset allocation of portfolio managers.

“The slow pace of Canada’s economic recovery means interest rate are not likely to dramatically increase, which means it will not drastically affect how we position our portfolios,” says Stephen Lingard, vice-president, director of research, Franklin Templeton Managed Investment Solutions in Toronto.

“We are not getting incredibly defensive on interest rate sensitivity,” he says. “We do have 25 % of the portfolio that would not really be interest rate sensitive at all. So while half of the portfolio may face a headwind if interest rates start going up, the other half is likely to rally.”

Canada is currently at a point in the economic cycle when interest rates begin to go up. “It is, though, a short-term phenomenon and I am not convinced that we are now on a significant cycle of higher interest rate,” says Lingard. He adds that any interest rate increases will be short-term in nature.

Financial services firms, however, are in a state of readiness, armed with tactical planning and portfolio positioning strategies to counter the effects of rising interest rates.

“We definitely have a tactical allocation process. We would absolutely reposition our portfolio to protect investors against rising rates,” says Lingard. He says there are a couple of ways to combat the rising interest rate scenario. One of that is inclusion of instruments less sensitive to spikes in interest rates. “Certainly there are a number of instruments within our fixed-income portfolios that are less interest rate sensitive,” he says.

He says the rate hike will likely impact government bonds the most, but some others could show strong performance in the given environment. “Our portfolios do have exposures to some of these parts of the market that actually benefit from rising interest rates.”

High yield bonds, corporate bonds, and some of the spread sectors generally do well in a rising rate environment, he says. “Typically, they represent a smaller portion than, say, government bonds, but they provide a nice hedge against the risk of rising interest rates.”

Because rising interest rates are an indication the economy is on the mend, investors can expect to see some part of the bonds market responding favourably, in terms of price performance.

(04/01/10)