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Marina Pomerantz & Neeraj Khosla | March 23, 2018

Why truly active managers aren’t afraid of rising rates

With interest rates starting to rise, many investors are wondering what impact, if any, the move upward might have on their portfolios. We asked Marina Pomerantz, a portfolio manager on the Trimark Global Equities team and Neeraj Khosla, an investment analyst covering emerging-market (EM) equities for the same team, for their views on the current interest-rate environment.

Putting things in perspective

Marina: I’d like to start by putting things in context a little. I see a lot of coverage in the media around interest rates, and I think it’s important to keep in mind that interest rates are rising gradually around the world. Historically, most recessions have occurred when there is a sudden and somewhat unexpected increase in interest rates. That is not the case today, given the tendency of central banks around the world to telegraph their moves well in advance.

The second thing that is important to keep in mind, in my view, is the reason why interest rates are rising. In today’s environment, the global economy is fundamentally improving, pushing rates higher. Generally, unemployment is down, wages are growing and asset prices are rising – this creates a wealth effect. When combined, these are favourable dynamics for economic expansion. Considered altogether, inflation remains more benign than headlines would suggest because core inflation measures recorded over the past 12-18 months have been quite moderate and energy prices continue to be range-bound.

Neeraj: In the EM space over the last 10 years valuations have been supported by the low-interest-rate environment. Amid the historically low-yield environment, investors were chasing higher yield, which channeled money into many EM countries.

Looking ahead to the impact of interest rates

Marina: We are long-term investors focused on quality. Our investment process typically doesn’t uncover many companies that meet our criteria in sectors like utilities, telecom or real estate. Those tend to be asset-intensive industries and companies in those sectors often rely heavily on borrowing in order to fund their business.

We tend to favour companies with low leverage, and asset-light business models that make them less sensitive to rising interest rates. Essentially, if the cost of borrowing goes up, companies that borrow less should perform more consistently during the rising-rate period.

Neeraj: Going forward, as monetary policy normalizes, a low-interest-rate environment should no longer be the support mechanism for emerging-market valuations. As this progresses, stock-market performance should be driven by company-specific performance – underlying business fundamentals, earnings and cash-flow growth.

While we do consider all of these broader economic and market considerations, from a fund management perspective, we focus on high-quality companies with defensible competitive advantages, organic growth, attractive free-cash-flow conversion rates and high returns on invested capital. This discipline provides us with confidence in the companies we invest in – confidence that they are able to deliver sustained earnings growth in any kind of market cycle.

Marina: We devote most of our time to finding and truly understanding companies that meet our investment criteria. Every business added to the funds is chosen based on the quality of the underlying business, the sustainability of its competitive advantage and whether the valuation is attractive in our estimation.

We do take macroeconomic considerations into account when developing valuation models for the businesses we invest in. We take care to ensure that we incorporate potential cyclicality into our forecasts and evaluate each company’s cash flow generation potential through a full market cycle. This leads us to build portfolios made up of what we believe to be the best ideas for the long term – whatever the long term may bring. If you have any questions for Marina or Neeraj, please don’t hesitate to leave a comment below.

More from Marina Pomerantz & Neeraj Khosla

Why truly active managers aren’t afraid of rising rates
March 23, 2018

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