As central banks tighten, it’s time to review investments that are sensitive to interest rates, including financials, real estate, telecommunications and utilities.
“We have a healthy 22% in financials — a lower weighting than our benchmark, which is skewed by the financial weight in the TSX,” says Chris Kerlow, CFA, in a Richardson GMP market report.
As rates rise, he says he continues to like the banks, which have attractive valuations in the 10x to 12x price-to-earnings range and good dividend yields.
“Holding us back from loving them is the heavy reliance on the housing industry, which we view as a risk,” he says.
Specifically, Richardson GMP prefers TD, RBC and BMO because they have growing U.S. businesses and provide attractive yields, at +3.5%. Further, they have lower exposure to housing relative to CIBC and National Bank.
On the U.S. side, the firm owns BB&T bank, which historically has a positive correlation with rising rates.
“If economic data in the U.S. continue to improve in the second half of the year and into 2018, we would expect bond yields to rise and regional banks to perform well,” says Kerlow, though one risk is financial deregulation delay.
Insurance and diversified financials
For interest rate protection, the firm has positions in Manulife and Sun Life.
As a globally diversified business, the former is positioned to benefit from global growth, says Kerlow; the latter is more focused in North America and offers a larger yield with less volatile stock, historically.
Diversified financials in the portfolio include Lazard and Virtu Financial.
Lazard is the sixth-largest M&A advisor in the world, which aligns with Kerlow’s view that deregulation and consolidation in a digital era should foster more transactions.
Virtu provides liquidity in thousands of products across global financial markets. “Unlike most companies, Virtu earns more when volatility spikes,” says Kerlow. “The stock also has a low correlation to both the S&P 500 and the TSX.”
Real estate, telecom, utilities
It’s challenging to add to real estate right now, says Kerlow, because of rising rates. The firm’s only holding is Pure Industrial REIT, which has performed well over the past year, with a 5% yield and good growth prospects.
The firm has no exposure to utilities, which underperform in a rising rate environment. “Valuations in this high-yielding, low-growth, defensive sector have ballooned as investors search for dividend yields as an alternative to bonds,” says Kerlow. However, “we are keeping our eyes on a few interesting plays that have exposure to the changing global energy mix.”
Telecoms, historically shown to be sensitive to interest rates, trade on fundamentals, says Kerlow. The sector will benefit as the internet of things proliferates. The firm holds Rogers and BCE, which benefit from scale as pricing for mobile users flattens.