Forecast increases in interest rates may give share market investors reason to pause and reconsider their portfolio positions in relation to exposure to long-duration shares.
Epoch Investment Partners portfolio manager John Tobin said share market investors should consider duration as a factor in their investment strategy in order to improve returns despite a high interest rate environment that was less favourable to long-duration positions.
“Keeping an eye on interest rates is a concept that is more familiar to fixed income investors and may be a little foreign for share market investors, but we think the concept of duration is relevant for equity investors and offers valuable insights in an environment where interest rates are likely to go higher,” Tobin said.
“To describe briefly how this concept of duration applies, it is understanding when cash flows occur, such as in the near future or distant future, and recognising that money has a time value. The value of $1 to be received 10 years from now is not the same value of $1 to be received today or next year.”
As a result of this, he said share market investors needed to consider what type of stocks they held in a rising interest rate environment.
He pointed out growth stocks – where revenues, earnings and cash flows where not expected for some years – may become less attractive than short-duration income-generating stocks that are generating cash flow and paying dividends today.
“Bond investors know in a rising interest rate environment the thing to do is to shorten duration,” he said.
“Our argument is equity investors need to be thinking along similar lines and they need to be thinking about the risk in their portfolios from holding long-duration equities in a rising [interest] rate environment, especially long-duration equities that have experienced significant price appreciation and multiple expansion in the past year or two.”
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