- Throughout the article, you will find information about interest rates and how their evolution can impact the underlying assets that make up an investment vehicle.
- The following information is useful for asset managers who want to understand how monetary policy influences decision-making when it comes to investing.
- FlexFunds investment vehicles can securitize multiple asset classes, allowing managers to take advantage of cyclical movements in rates on the underlying assets. Contact us.
Interest rates are a fundamental element in the investment scheme. Their influence extends to a wide range of underlying assets with which an investment vehicle can be constituted, from publicly traded stocks to real estate assets.
What is the link between the price of money set by central banks and different investment assets? It is interesting to observe how rate fluctuations affect stocks, bonds, the real estate market, and other segments, and how investors can make strategic decisions based on these changes.
Interest rates and stocks
Monetary policy developed by central banks directly impacts the financial markets and equities. When interest rates are low, investors tend to seek higher returns in the stock market, which can boost prices, on average.
An example is the S&P 500 rally from 2009 lows to 2021 highs. The era of low rates provided investors with average returns on the index of over 14% annually.
Companies can also benefit from lower interest rates as borrowing costs decrease, which, in turn, can increase their profits.
On the other hand, when rates rise, investors may find investments in bonds or other fixed-income assets more attractive compared to stocks. In 2023, for example, the 10-year US bond reached above the 5% threshold, a level not seen since 2007.
This can lead to a decrease in demand for listed securities and, consequently, to a decline in prices. Additionally, companies may be negatively affected as borrowing costs increase, reducing their profit margins.
Bonds and interest rates
Bonds are directly influenced by changes in interest rates. There is an inverse relationship between the valuation of bonds and interest rates. When rates increase, the prices of existing bonds tend to fall as investors demand higher interest for debt investment.
On the other hand, when rates fall, bond prices rise as those with higher interest rates become more attractive.
This relationship between fixed-income products and rates is crucial for investors seeking to maintain a balance between risk and return in their portfolios. During periods of rising interest rates, they may choose to invest in shorter-maturity bonds to mitigate capital losses.
Impact on real estate assets
Interest rates also play a significant role in the real estate market. Mortgage rates, for example, are closely linked to long-term rates. When these are low, financing costs for buying a home are lower, which can stimulate demand for real estate and increase property prices.
However, when cash prices rise, financing costs increase, which can slow down housing demand and negatively affect the real estate market. This would lead to a decrease in property prices and reduced activity in the sector.
Additionally, it also has the ability to influence commercial real estate. Commercial real estate investors often use loans to finance their acquisitions. When rates are low, borrowing costs are lower, so there is a possibility that the profitability of investments in this field may increase.
Strategies for asset managers
Given the influence of interest rates on investment strategies, managers must develop solid approaches to adapt to their fluctuations. The most common strategies are as follows:
- Portfolio diversification: Maintaining a diversified portfolio that includes a variety of assets can help mitigate risks associated with changes in rates. When one asset is negatively affected by an increase in rates, others may benefit.
- Tracking rates: Managers should keep abreast of trends in interest rates and adjust their portfolios accordingly. This involves selling assets sensitive to changes in the price of money when an increase is expected and buying them when a decrease is expected.
- Short-term bonds: During periods of tighter monetary policy, short-term bonds tend to be less sensitive to changes in rates compared to long-term fixed income.
- Alternative investments: Managers can explore other options, such as real estate investment trusts (REITs) or commodities, which may behave differently in changing interest rate environments.
Therefore, interest rates are a key factor in investment decision-making. They have a significant impact on a variety of investment assets, from stocks to bonds.
Diversification, rate tracking, and selecting suitable products are essential to managing a portfolio in a more dynamic environment.
If you have any questions, you can contact one of our experts for assistance.
