A rising interest rate environment comes with its own set of hurdles and the relative impact of inflation and rising rates is visible in the markets. Rising inflation and thereby tight monetary policy lead to market volatility, weakening investor sentiment.
In the last 15 years, central banks kept interest rates lower to support growth amidst multiple crises starting from sub-prime to the most recent Covid-19. However, one of the aftermaths of easy liquidity is that it fuels inflation, which the world is already witnessing since the start of this year.
Moreover, the third wave of the Covid-19 and Russia-Ukraine war has further exacerbated and elongated global supply chain disruptions which have spooked inflation levels globally.
The US for example had annual inflation of 8.3 percent in April and 8.5 percent in March which was a 41-year high. The UK inflation also hits 9 percent, a 40-year high. India, too, saw its retail inflation numbers rising to 7.79 percent which was well above the RBI inflation level target of 4 percent (with a tolerance band of +/- 2 percentage points).
For Central Banks, this is a big problem since the negative effects of high inflation are considered more harmful than the positive effects of easy liquidity. Hence, central banks have set out on a path to rapidly increase rates and put a cap on rising inflationary pressures.
In this rising interest rate environment, it is important to understand how to position your portfolio. Edelweiss Mutual fund (MF) has come up with some recommendations for the same.
Across its long-only equity funds, the MF said that it has positioned the portfolio well to navigate the current situation and has been adding more exposure to businesses and sectors that may be resilient or benefit during the current economic phase of high inflation and rising interest rates.
The MF stated that it is broadly positive on the below sectors across portfolios and has actively taken overweight positions in select quality businesses within these sectors.
1. Consumers: As per Edelweiss MF, consumer companies that have pricing power continue to do well during high inflation interest rate regimes due to their essential nature in day-to-day consumption. They tend to hold their demand and margins during high inflationary regimes as demand for such goods generally tends to be inelastic to inflationary pressures, it noted. Within this space, it is selectively positive on businesses that have pricing power and have better brand acceptance.
2. Industrials: When interest rates rise the economy is usually on a stronger footing to withhold this regime change and hence, industrial activity tends to remain strong and resilient, said Edelweiss. It added that industrial manufacturing businesses are also mostly beneficiaries of high commodity prices since they can pass on the higher cost without impacting demand to a large extent. It has actively taken exposure to such industrial manufacturers who have pricing power and demand is picking up for their products. These are businesses that have done well in the last couple of rising interest rate cycles, said the MF.
3. Lending financials: The financial sector has historically been among the most sensitive to changes in interest rates, noted Edelweiss. With profit margins that expand as rates climb, entities like private banks and lending financials benefit from higher interest rates, it pointed out. It has active exposures in such lending financials across our portfolio, mainly select private-sector lenders and some dominant lending franchises that are expected to do well in this cycle.
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