Why I’m changing nothing in anticipation of the US Fed rate rise
In preparation for the US Fed rate increase Clare Hart, fund manager of the JPM US Equity Income Fund, says she is changing – ‘absolutely nothing’
There is a paradigm shift coming, with the US Federal Reserve likely to soon raise interest rates this year for the first time in nine years. In terms of what I’m doing in my portfolio in anticipation of this seismic change: absolutely nothing.
Certainly we’re prepared for higher volatility and we expect to see sell-offs in higher yielding equities. History teaches us that volatility picks up prior to and during an initial rate hike, although equities tend to regain positive momentum after a few months of adjustment.
I’m not taking action to reposition my portfolio in reaction to the looming Fed move because that’s simply not how I invest. As a long-term US equity income investor, I buy high quality companies that have the staying power to outperform while also delivering a sustainable dividend of 2% or more. Irrespective of the rate cycle, I’m positioned for the long-term.
What if there’s a sell off?
In the event that we do get a meaningful sell-off in higher yielding sectors around a rate increase, that could be a buying opportunity. The way the S+P 500 moves, it’s perfectly normal to get a drawdown of 3% to 5% a few times each year, and it’s possible we will see that type of drawdown around the Fed rate hike. If that happens, we would be looking for attractive entry points where we think the underlying company business story meets our investment criteria. A dip in prices may give us an opportunity to add high quality names that we feel are warranted in the portfolio. We don’t buy stocks hoping that they grow into their valuations; instead we pick them based on strong fundamentals, durable franchises, consistent earnings, attractive valuations and strong management teams.
On the other hand, if expectations around the rate increase have been so heavily telegraphed that it becomes consensus to expect a sell-off, then we may not see that happen. What we may get instead is a continuation of what we’ve seen so far this year, with a selective sell-off in certain sectors, such as REITs and utilities. Again, as a long-term investor I don’t play the game of trying to time these themes.
Fundamental questions more important than rate rise plays
It comes down to having the right stocks in the portfolio, and what I look for is a combination of value and quality. Does the company show sustainability and durability of the earnings? Am I comfortable with the business model and the consistency of earnings? Has the company behaved in a way to earn the respect of investors across business cycles? All of these questions are a lot more important than simply making a play on interest rates going up. Ideally we want to own companies indefinitely – stable earners that pay a dividend and will be recognised by the market over time for their performance.
Just because we don’t invest on the basis of interest rates or other macro factors, that isn’t to say some companies in our portfolio aren’t poised to benefit. A good example of this is Wells Fargo, currently our largest holding in the portfolio and a company we’ve held for over five years. The market doesn’t fully recognise their strong franchise in US retail banking and the strength they gained with the acquisition of Wachovia following the financial crisis, which gave them a solid national retail footprint. With a stable management team, straightforward business model, strong earnings, a robust balance sheet and limited exposure to more volatile areas of banking, we think they are positioned to continue to grow earnings in a rising interest rate environment that will even further benefit their net interest margins. They’ve also raised dividends six times since the financial crisis, outperformed the S+P 500 in four of the past five years, are outpacing the market so far in 2015 and are trading on 12x P/E relative to a market average of 16.4x. In short, we continue to see value and significant earnings potential in Wells Fargo, but the anticipation of rising interest rates is just one piece of a much more fundamentally driven puzzle.
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