For some time now investors have been waiting for signals interest rates will start falling. This has meant a lot of focus on monthly inflation updates, with central banks patiently waiting for rising prices to be seemingly under control again before they start cutting rates.
We thought we were in that position towards the end of 2023. At that time, rate rises were firmly put off the table by central banks, with the last rate increase from the US’s Federal Reserve (Fed) coming in July 2023.
The result of that false dawn? Bond prices increased sharply into the end of the year and shares saw wide ranging rises too.
However, the mood was short lived. It became clear that while further rate rises were unlikely, rate cuts were still some way off. Bond markets corrected and lost value during the first quarter of 2024, giving back some of the previous gains.
Six months on and it feels like now there’s definite room for central banks to actually start cutting rates.
The European Central Bank has already started. It cut rates by 0.25% in June, with more cuts expected throughout the year.
Annual inflation to June 2024 in the UK came in at 2% and 3% in the US. And there have been signs of economic weakness, so investors have once again shifted to focus on when rate cuts might start.
This article isn’t personal advice. Investments can rise and fall in value, so you could get back less than you invest. If you’re not sure if an investment’s right for you, ask for financial advice.
Funds for falling interest rates
Investing in these funds isn’t right for everyone. Investors should only invest if the fund’s objectives are aligned with their own, and there’s a specific need for the type of investment being made. Investors should understand the specific risks of a fund before they invest, and make sure any new investment forms part of a diversified portfolio.
For more details on each fund and its risks, use the links to their factsheets and key investor information.
Invesco Tactical Bond
First thoughts turn towards bonds. Bond prices usually fall when interest rates are rising and rise when they’re falling.
There’s also some caution needed, because the journey for inflation to come under control is likely to be a bumpy one. There’s still potential for inflation to increase at times while staying on a downward trend. So, this could cause ups and downs in bond prices.
But with yields higher than they’ve been for many years, and interest rate cuts expected, we think this is a good entry point to buy bonds.
We think Invesco Tactical Bond is well placed to take advantage of a rate cutting cycle. It’s been altering its investments to benefit from rate cuts more recently.
We can see this in its duration position which, at around 7.9 years, is close to the highest it has been over the last ten years in the fund.
Duration is a measure of how sensitive an investment is to interest rate changes and is measured in years. The higher the duration value, the more sensitive the investment is to interest rate changes.
The fund is co-managed by Stuart Edwards and Julien Eberhardt, who make use of the large amount of flexibility they have over what bonds they buy for the fund.
The fund invests in high yield bonds and uses derivatives, both of which add risk.
FTF Royce US Smaller Companies
We think smaller companies present an interesting opportunity in a rate cutting environment.
Smaller companies have generally struggled during the rising rates. Partly because their revenues can be more linked to the health of the economy and because their borrowing costs often aren’t fixed. Both factors can reduce their growth prospects.
The opposite is also true as rates come back down, making them an interesting investment. But smaller companies are generally riskier than their bigger counterparts.
Smaller companies in the US could be a good place to invest right now. While these companies are small in comparison to some of the huge businesses which make up the US stock market, many of them would be considered big anywhere else in the world.
We think the FTF Royce US Smaller Companies fund is a good option for this. Lauren Romeo has managed the fund since 2010, honing her investment philosophy over this period.
Baillie Gifford Sustainable Income
Finally, for more cautious investors, multi-asset funds might be appealing – particularly those with investments in bonds and investment trusts.
Investment trusts have struggled during the rate rising cycle, especially those investing in property and infrastructure. This is mainly because one of the key attractions of these trusts is income.
As interest rates and bond yields increased, the demand for these types of trusts has fallen because the level of income they pay isn’t much more than cash or bonds now. So, a number of them are trading at a discount to their net asset value.
Looking forward, this has the potential to reverse and add to any returns, however, there are no guarantees.
We think the Baillie Gifford Sustainable Income fund is a good option in this environment. It’s neutral asset allocation includes arounda third invested in infrastructure and property and another third invested in bonds. The remainder is usually invested in shares and cash.
It’s managed by a number of experienced individuals at Baillie Gifford. And the diversified nature of the fund means that even if rate cuts have differing impacts on different regions and investments, the fund has potential to benefit.
The fund invests in emerging markets, high yield bonds and derivatives, all of which add risk. It also takes charges from capital which can increase the income paid, but reduce the potential for capital growth.