Global equities: How to navigate investing in a higher-rates world

Higher interest rates are already flowing through to company reports. But have investors adjusted to the new reality? SAMIR MEHTA outlines strategies for a higher-rates world

• Higher rates are changing the game for investors
• Near term cashflows are key
• Find out about Samir Mehta’s Pendal Asian Share Fund

IF rates stay higher for longer, investors need to rapidly rethink what has worked in recent years.

That means a few things, says Samir Mehta, portfolio manager of Pendal’s Asian Shares Fund:

• Doubling down on valuation as a critical investing metric
• Understanding the ramifications of tighter credit on business finances
• Carefully considering the second and third-order effects of higher rates, and
• Focusing on near-term cashflow generation ahead of future earnings projections.

The effect of higher rates is already showing up in Asian company reports, says Mehta.

For example, Korean battery maker LG Energy Solutions recently told shareholders that electric vehicle sales would slow next year due to higher rates.

A luxury residential project in Seoul is in difficulty after failing to get an extension on US$344 million in bridging loans.

Altice, a telco giant built by French-Israeli billionaire Patrick Drahi, has put everything it owns up for sale as it struggles to service US$60 billion in debt.

India’s outsourcing industry, a bellwether for the health of global firms, shed more workers last quarter that any comparable period in the past five years.

Borrowing by governments, companies, consumers, and financial firms across Asia is well above levels prior to the global financial crisis, lifting the risks of default, according to the IMF.

“The question is — are the rules of the game changing?” says Mehta.

Find out about

Pendal Asian Share Fund

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“We lived through a world with very easy to access capital and low rates as central banks were adding liquidity.

“That environment has shifted, but I don’t think that most of us have as yet adjusted our thinking around what new environment we’re living in.

“The mindset of every economic participant has to now turn on its head 180 degrees.”

Near term cashflow beats future earnings growth

Adjusting to a new world of tighter credit potentially means moving away from investing strategies that have worked in the recent past.

“When rates were low, cost of capital was subdued,” says Mehat. “You had to own assets with long duration cash flows well into the future.

“That was partly because perceptions about growth in the future can’t be tested — assumptions are just based on people’s imaginations — and partly because at a low discount rate, the present value of those future cash flows is amplified.”

In today’s world, investors should instead be looking for cash flow that can be generated in the near term, with a higher degree of certainty, argues Mehta.

That means gravitating towards companies that can find cost savings, reduce working capital and cut capital expenditure; preferably using that cash generation to buy back shares and reduce debt.

“The ability to generate cash today is more important than cash in the distant future.”

Second and third-order effects

This year’s frenzy for AI stocks and weight-loss drug manufacturers are echoes of the low-rate era, Mehta believes.

“Everyone’s coming out with assumptions and predictions of what the impacts may be — but it’s all in five, ten, fifteen years.”

A similar story has played out in recent years for companies supplying the renewable energy industry, he says.

But as the costs of finance rises, these industries will find it harder to raise the capital to continue to invest in what are often unprofitable projects.

“As an investor, you must think about the ramifications of higher interest rates on the businesses themselves — not only the effect on household and mortgage holders.

“Many of these companies have been tolerated by investors because the cost of financing has been very low.

“But as the cost of money has gone up, all of a sudden, the viability of many projects is in question.

“It’s a chain reaction. In solar and wind projects, the equipment manufacturers that supply into these projects are now feeling the pinch.

“In semiconductors, it’s not only the chipmakers feeling the pressure, but their suppliers.

“In China, the bursting of the property bubble is having a follow-on effect on not just suppliers of steel and cement but even real estate agents finding that they have commissions that haven’t been paid.

“You have to step back and change the aperture of your lens to think about business community as a whole.

“That is the ramification of the rising cost of money. And the speed of that rise hasn’t hit us yet.”

Caution warranted

Above all, Mehta urges caution.

As credit tightens, businesses fail and unemployment rises, many analysts expect central banks and governments to go back to their old ways – cut interest rates and inject liquidity.

“Some macroeconomic gurus take the view that a potential geopolitical crisis could compound an economic downturn.

There are bond bulls who think that a slowdown or recession will mean central banks will have to moderate their stance on raising rates and therefore we are close to the peak of the interest rate cycle. 

“But if the rules of the game have changed, we really must question even that assumption of central banks injecting liquidity.

“Because if you think about it, in my view, what the Federal Reserve and other central banks got wrong is that their ultra loose policy exacerbated the inflation problems we are facing.

“If you were a central bank faced with an economic downturn yet lingering inflation pressures, would you take the same path you did during COVID?

“Or are you also going to change the way you think about the world?”

About Samir Mehta and Pendal Asian Share Fund

Samir manages Pendal Asian Share Fund, an actively managed portfolio of Asian shares excluding Japan and Australia. Samir is a senior fund manager at UK-based J O Hambro, which is part of Pendal Group.

Pendal Asian Share Fund aims to provide a return (before fees, costs and taxes) that exceeds the MSCI AC Asia ex Japan (Standard) Index (Net Dividends) in AUD over the medium-to-long term.

Pendal is a global investment management business focused on delivering superior investment returns for our clients through active management. 

Contact a Pendal key account manager here