Shift In Monetary Policy Posture: An Investor’s Playbook | Barita Insights | August 30, 2021

Analyst Insights

Shift In Monetary Policy Posture: An Investor’s Playbook

Last week we discussed the implications of a shift in monetary policy from an Economic Perspective, which sets the operational backdrop for businesses and dictates how asset classes could perform. This week, we focus on the implications of this shift to the different asset classes and subsequently the playbook to guide investors’ decisions.

Operational Environment

Inherently, the mandate of monetary authorities is to create an environment with stable levels of inflation and low levels of unemployment. In an expansionary environment, policy rates are low and Open Market Operations (OMO) are geared towards providing liquidity to the financial system through purchases (by buying securities, they acquire assets and give cash to the financial system). The opposite occurs when there is a tightening of policies, that is, policy rates increase or in some cases, policymakers take liquidity out of the market through sales (by selling securities, they are removing liquidity).

The monetary authorities will cycle through these tools available to them to meet the mandates stated above. In the contractionary environment, financial intermediaries will follow the guidance of monetary authorities. That is, when policy rates rise, banks would essentially charge more from their clients on loans. As an example, when we examine the historical relationship between then 30-Year US Treasury Rate and 30-year US Mortgages rates, these variables move in lockstep. This relationship reflects that as the yield curve steepens due to an increase policy rates, there is a higher cost to obtain a 30-year mortgage for home purchasers. As such, clients will have to be willing to pay more for a loan (in the form of higher mortgage rates).

During a contractionary environment, asset classes operate a bit differently. However, at the core of it, the reason for the policy change is the key determinant of how investors should be positioned. That is, if you can exam the differing policy decisions based on changes in economic developments (such as the 2008 Financial Crisis, COVID-19 Pandemic, Internet Bubble Burst, or the collapse of Long-Term Capital Management in 1988), you get an idea that the policy choice isn’t the determinant of investment decision but more the response to economic developments. As such, the current pandemic has created key pockets of opportunities across the different asset classes:

❖  Equities: Despite the elevated levels of equities overseas, banks are primary beneficiaries in a contractionary environment as they are now able to charge higher rates on their loans. This creates a positive tailwind for the financial industry. As such, gaining exposure to entities within the financial services industry will be a key portfolio positioning in a contractionary environment. Both locally and internationally we see where financials lag the broad index level recovery, trading at a discount to the broad index level which has become elevated due to the large recovery in 2020 led by Technology stocks. Continuing to position one’s portfolio towards recovery stocks will also provide adequate upside as the source for inflation will be the onboarding of the rest of the economy. As such consumer discretionary, materials, and industrials will also be key areas to have exposure to. In the case of the local stock market, Manufacturing & Distribution (M&D) will continue to have positive tailwinds supporting them with the financial stocks being the main primary beneficiaries in a rising interest rate environment.

❖  Fixed Income: Variable rate notes will be the most attractive fixed income securities to investors, especially those anchored to a benchmark interest rate or have step-up features. These features are positively correlated with interest rates, such that as rates go higher, so do the coupon payments. This will be of particular interest to those seeking coupon payments, especially since fixed coupon payments would have been eroded due to inflation. Also, issuers who operate within the recovery sectors will see improvement in their credit metrics leading to potential upgrades which historically leads to capital appreciation. Investments should be focused on companies with strong balance sheets and operational environments as the cost of borrowing will theoretically be higher, increasing credit risk as refinancing debt will become expensive.

❖  Alternative Investments: While this is a broad area, the asset class, is in our view, has the highest potential for generating returns. Financial companies that offer alternative means of financing to middle-market companies will see higher levels of performance. Bank loans will be an attractive security for potential exposure given the higher rates to be charged on loans. Real estate will continue to act as a hedge against inflation.

It should be noted that despite the potential pivot in policy stance, there will continue to be pockets of opportunities across the different asset classes. Where investors are not able to get direct exposure, investing in collective investment schemes (CIS) such as Unit Trust products will allow for indirect exposure and offer a comparable return. They are also a more affordable option for most due to their cost optimization. As such, speaking with your financial advisor is essential to ensure your portfolio is correctly positioned to benefit during this period.


Written by Haughton Richards, FRM, FMVA, Senior Investment Strategist
Unit Trust Fund 26/08/2021 18/08/2021 Week/Week Return Year-to-Date Return 1 Year Return Yield
Capital Growth 91.70 92.69 -1.14% 7.50% 20.25% -
Money Market 15.1404 15.1364 0.03% 2.47% 2.68% 2.15%
Income Portfolio 100.00 100.00 - - - 2.67%
FX Bond Portfolio (US$) 1.3687 1.3681 0.04% 0.92% 4.79% 2.03%
Real Estate Portfolio 5,400.48 5,409.24 -0.16% -7.45% -4.77% -
FX Growth Portfolio 1.0585 1.0365 2.12% 6.01% 6.37% -

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