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How to Invest in a High-Interest Rate Environment 🔌

In a synchronised manner, the world has gone into a rather contractionary phase. Hit hard by inflation, central banks across the globe are rising rates to slow things down.

A rising rate environment makes investing pretty tricky. Stocks don't do well, and neither do bonds. Liquidity becomes a problem too, and a cautious approach envelopes every investment decision.

But not all is dark! There are always pockets of opportunity, whatever be the environment. Here’s how you can make money even in a rising rate scenario.

Equities 💎

The Bad

The Good

​Companies that are highly leveraged (have high amounts of debt) with a floating component might feel the burn with debt servicing costs going up.

Vedanta, for example, has raised debt from various domestic sources (LIC being one of them), at a floating rate, before the rate hikes.

Sectors like FMCG and IT, that don’t require high amounts of leverage to function because of high cash flows and profit margins. They’re better placed to tide rising rates.

ITC is a good example of negligible debt, and has been a top performer amongst Nifty stocks.

​If the companies raise debt from foreign investors, there is an added pain from currency depreciation. They have to now pay higher interest rates, and higher currency conversion - a double whammy!

For example, REC had heavily borrowed via External Commercial Borrowings before the rupee depreciation spree, and although hedged, this may affect them detrimentally.

The future cash flows of a company on today’s date is what any stock’s fair value is. However, when rates rise, the discounting factor increases, and the fair value reduces. Because of this, value stocks perform much better than growth stocks - plainly because of higher cushioning.

PSU banks are a good example of low valuations, and superior stock performance.

Bonds 💼

The Bad

The Good

Fundamentally, as interest rates rise, bond prices fall. Bonds hence don't perform too well, unless you’re correctly placed on duration and risk.

Whenever there is an increase in interest rates, it stands to reason that the rate paid on newly issued bonds would also increase.

These increased yields encourage buyers to return to the bond market.

Junk bonds are bonds with a lower credit rating, which means they are more likely to default. As interest rates rise, the value of junk bonds typically fall more than government-backed securities due to the lower credit risk in those.

Hence, if you’ve invested in junk bonds, you will lose more in the price free-fall.

In a rising-rate environment, short-term bonds often do better than long-term bonds because they are less sensitive to changes in interest rates.

Shorter duration means lower future cash flows, which mean lesser discounting, and hence lower negative impact on prices.

Commodities 🌾

The Bad

The Good

In a rising rate environment, liquidity is sucked out of the system, reducing the ability of companies and individuals to spend and slowing the economy down.

If the economy slows down, demand reduces, and there is downward pressure on commodity prices.

Usually, inflation is the reason rates go up. Commodity prices drive a lot of the inflation, as they form the basis for any raw material or consumption items.

Hence, during inflationary times, investing in commodities is equivalent to being on the right side of things.

In general, rising rates and economic uncertainty lead to higher volatility in the markets. To top it up, commodities have higher volatility.

In such an environment, swings in commodity prices can be quite wild and may require a very high appetite from investors.

During times of increasing uncertainty, investors usually flock to perceived safety - like Gold.

Demand for investing in Gold increases, and that keeps prices afloat or even higher. Gold can be a good investment during such times.

Real Estate 🏡

The Bad

The Good

As loan servicing costs rise, many are reluctant to purchase new homes. A year ago, the EMI on a new home would have been significantly lower than it will be now.

Because of this, demand falls and housing prices fall with it.

The result is a stifling of real estate's potential for appreciation in value

REITs and InVITs perform well in this situation. That is because they offer a consistent cash flow in these unstable times.

Because these trusts receive monthly rental payments, the macro scenario has little effect on their day-to-day cashflows.

In REITs, Embassy Office Parks REIT, Mindspace REIT (owned by Raheja Group) and Brookfield India REIT have a dominance, ranging from tech parks, hotels and residential property under their portfolio.

In InvITs, Indigrid InvIT, PowerGrid InvIT, and IRB InvIT are publicly listed and deal more with road infrastructure and power transmission projects.

While it is challenging to make investments in such a climate, there are always hidden opportunities for financial gain. To find opportunities within these macro headwinds, one must examine the ways in which particular niches are impacted.

It is possible to make money even in a struggling economy, you just have to know where to look!

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