What should PMs do about negative interest rates?

With central banks keen to lower rates further, it’s time to think about how to position portfolios

What should PMs do about negative interest rates?

Those following financial markets at a global scale are aware that in some weird cases, borrowers are actually paid to take on debt. The cause, in a nutshell, is an aggressive drive by central bankers spur economic growth and stave off a deflationary spiral by lowering interest rates.

This opens up a strange new world of portfolio management, one where PMs must ask truly unorthodox questions and consider making unusual adjustments. In a blog post published by the CFA Institute, Gautam Dhingra, founder and CEO of High Pointe Capital Management, laid out some key considerations, starting with the likelihood that central banks will continue cutting rates.

“Recent statements from Jerome Powell, Mario Draghi, and Christine Lagarde clearly indicate as much,” Dhingra wrote, asserting that they will continue until either inflation stays consistently above the 2% target, or there’s a break in the financial system that clearly indicates that markets can’t tolerate such low rates.

Have these monetary policies been successful in their objectives? While there’s no consensus, Dhingra said that they’re broadly seen to have propped up the prices of stocks, bonds, real estate, and other risky assets over the last several years. He also pointed to other negative consequences such as market distortions, artificially incentivized risk-taking, heightened inequality, and undue punishment of savers.

“[P]ortfolio managers should think about these monetary policies and their likely future path and determine whether their clients have a sufficient margin of safety,” he said, offering specific strategies to apply for different asset classes.

With regards to equities, he recommended underweighting both debtors and creditors unless their valuations become more compelling. Highly indebted companies that get by only by the good graces of central banks are not advisable to own in the long run, while low interest rates reduce the profitability of creditors. “Moreover, since banks apply substantial leverage in their business, they will be the first line of defense should the financial system start to take on water,” Dhingra added.

On fixed income, he recommended abandoning the typical path of intermediate duration, investment-grade corporate and mortgage-backed bonds. Instead, he argued for devoting a portion of the fixed-income sleeve to Treasuries — not broadly diversified money market funds — as a hedge against deflation. “Those concerned about the possibility of runaway inflation should also consider investing in Treasury Inflation-Protected Securities (TIPS),” he added.

He also suggested that investors gain some exposure to physical assets, such as commodities and precious metals, as well as companies that own such assets. He pointed to their diversification benefits, as well as the potential safe-haven properties offered by certain specific assets like gold.

“Over the last few decades, modern portfolios have shunned gold because it doesn’t produce any income and, therefore, the opportunity cost of holding it was significant,” he said. “In the current era of low and negative interest rates, that opportunity cost is less of a factor.”


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