This discrepancy implies that P/E ratios will come down when interest rates normalise, and that investors’ returns will be a lot lower than they could expect by only looking at earnings forecasts. However, says Pitoun, there are a couple of factors that will help smooth the impact of rising rates for him.
“First, we never invest in indebted companies, so in that sense our portfolio is insulated from the risk that comes with rising interest rates,” he says, adding that rates only tend to rise when underlying GDP growth is healthy, which would in turn be positive for companies’ profitability, which even in the current low growth environment already is pretty high. The record cash holdings of investors could provide some cushion too. “There is a lot of money on the sidelines that could be invested in equities,” underlines the Frenchman.
Switch to absolute return
GMO’s Inker, however, believes that the eventual fall of discount rates back towards ‘normal’ levels will be so powerful that a shift towards short-duration assets is warranted. “The impact of a 1.5% increase in the discount rate on equities from here is a fall over over 30%, which would almost certainly be enough to swamp the (positive) earnings impact of decent growth,” he says.
Since they yield higher returns than cash but tend to have low duration, alternative funds are the place to go, believes Inker. And European fund buyers seem to agree: the popularity of most conventional asset classes is low or fading, with the exception of emerging market equities: the only asset class to actually see discount rates rise since 2009 (as EM central banks have hiked rather than cut interest rates). Absolute return funds, on the other hand, remain comparatively popular. Global macro, multi-strategy and long/short equity funds are all in vogue.
