Which Income Stocks Will Benefit from an Interest Rate Rise?

Interest rates have been at a record low level for more than six years but it is looking increasingly likely that the Bank of England will raise rates within the next year

Emma Wall 12 May, 2015 | 2:42PM
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Emma Wall: Hello and welcome to Morningstar. I am Emma Wall, and I'm joined today by Clive Beagles, Fund Manager for J O Hambro Capital Management.

Hello, Clive.

Clive Beagles: Good morning.

Wall: Thank you for joining me here at the Morningstar Investment Conference. You've just done a great presentation on interest rates. I think investors hear a lot about interest rates and when they are going to rise. But what impact does that actually have on a portfolio because it's good news for those people who want to put deposits in a bank, and bad news for people who have mortgages. But what does it mean for investors?

Beagles: Well, the thing is we've been working in environment where interest rates haven't gone up for five years. And as a result, that's had a quite bigger impact on how different certain stocks and sectors have been valued in the equity market.

So for us the key element actually is, certain stocks and sectors will do well, as interest rates rise; and actually some might do quite badly and some of those maybe sectors that people have previously have thought about as being very defensive. Those actually maybe some of the stocks that fare worst in an environment in which interest rates rise.

Wall: And one of the sectors that you highlighted that could do well if interest rates rise is banks. Now banks are pretty controversial stocks. I mean, especially in the last couple of weeks where HSBC (HSBA) threatened to pull out the U.K. market; Clydesdale Bank threatening to pull out because there is so much risk around with PPI fines and all of that. But you are bullish on them?

Beagles: Well, in many respects, I think, we've got to a breaking point and actually I think HSBC's comments in a way, well, maybe they'll bring about a major change and the problem for banks has been the regulatory goalpost, if you like, are continuing to shift to the right and every time you've – or the best description I think is that regulation has been written in pencil rather than pen. As one of the thing they are, they just rub it out, change the rules and start again.

And I think people like HSBC beginning to say, well, this is getting so tight that if you don't do something about it, we're going to redomicile to Hong Kong, that's clearly a threat and we will see whether they react. But I think it reduces the risk of further regulatory drift in a more draconian way. Regulation in UK banks is probably the tightest of any nation in the world already.

So, if that's the case, then actually their sort of valuation basis can begin to reflect, companies can begin to grow dividends and return capital, Lloyd's (LLOY) obviously return to the dividend list and would like to distribute quite a high proportion of their earnings and dividend. If they do that, I think the stocks look quite attractive.

So we've been quite slow to embrace banks because of this regulatory concern, but I think we are getting to a point where it struggles to get much worse.

Wall: And I suppose in a way, if everyone was singing and dancing about them, they wouldn't be attractive to you because you like contrarian best?

Beagles: We do. Yeah, and I think that's exactly sort of area. If you look at the areas that we currently find attractive is things like financials, it's areas like commodities or it's small cap all of which are less fashionable. That's what we do. We tend to dig around in parts of the market, other people don't like and tend to leave the more fashionable areas that right now would be biotech or technology or staples all of which to us; lots of good companies in there, but they are valued on quite high multiples, and it's hard for us to see how you make money in those sort of names, and more likely to make better returns from lower valuations as your starting point.

Wall: And you are rewarded with yield for that, but will you get some volatility in the share price along the way?

Beagles: Well, you might do in some respects because remind we talked about where interest rates are probably going to go up, probably will lead to slightly volatile overall market environment. But in our opinion, the defensiveness best manifests itself in low valuations rather than what industry the company sits in.

I think they will lose sight of that. So a small company on six or seven or eight times earnings with a good balance sheet and they will be more defensive than a company in a consumer staples area on 23 times earnings with lots of debt and yet most people tend to think that those staples companies are more defensive than the other ones.

I'm not saying I'm wildly cautious about market, it's about thing where probably due to a period of volatility which might amount to sort of up and down but netting towards zero overall for the market. But we can still find lots of individual names that we think still look interesting.

Wall: Stock selection is key?

Beagles: Well, it always is, yeah, I mean, that's a reality. That's what we do. You know, we don't invest in economies, we invest in companies and ultimately that's what drives performance.

Wall: Clive, thank you very much.

Beagles: Thank you.

Wall: This is Emma Wall for Morningstar. Thank you for watching.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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Securities Mentioned in Article

Security NamePriceChange (%)Morningstar
Rating
HSBC Holdings PLC512.80 GBP0.00Rating
JOHCM UK Equity Income A GBP Acc4.28 GBP0.26Rating
Lloyds Banking Group PLC46.18 GBP0.00Rating

About Author

Emma Wall  is former Senior International Editor for Morningstar