Where and how to lock in your returns

Pros and Cons of higher interest rates: The past two years of high interest rates have had negative implications for many asset classes and inversely, presented many buying opportunities for investors. Locally, higher interest rates (and the tight Jamaican dollar liquidity conditions) translated to lower local equity valuations (and thus less “upside” potential). Higher interest rates also increased the cost of debt for corporations and lowered dividend payouts to shareholders. Some local corporates found themselves extending their maturing debt due to the tight liquidity conditions in the market which made refinancing a challenge. Mortgage financing also got more expensive and thus housing became less affordable. More expensive mortgages can result in a weaker demand for real estate and thus dampen short term prospects of property appreciation. However, softer asset prices presented an opportunity for investors to lock in attractive yields and valuations on some assets. In sum, higher interest rates created problems but also provided opportunities. 

When to buy:  Frequently we are asked “when should we buy, do we wait for the market to go lower, do we wait for the Fed to start easing?” It is impossible to answer this question with perfect clarity. However, you don’t have to wait until the start of the loosening cycle to consider purchasing assets. In fact, some of the Federal Reserve’s easing has already been reflected in asset prices. Markets move in anticipation of future movements. Here is a glimpse of what we are considering in the current market:

What to consider buying:

• Longer dated bonds: Lock in the yields on longer dated fixed income securities. These have the highest price appreciation potential and are also likely to attract higher coupon rates than shorter dated notes. It is important to remember that you do not have to hold an instrument to maturity. Check the liquidity of the instrument to ensure that it is easy to exit and check the credit quality to ensure the issuer will be around to service and refinance/repay the debt.
• Go down the capital structure: For investors desirous of higher yield, consider going further down the capital structure to get more return on a good quality credit. In other words- buy bonds that are “further back in the line to be repaid”, or bonds that sit right above equity, or bonds that have “quasi equity” type features. It is possible to get 20% - 50% more yield on a deeply subordinated note than it is on a senior unsecured note. There are risks that accompany this strategy, therefore it is important to ensure you are adequately compensated for them.
• French assets sold off significantly with the recent political uncertainty. Some investors purchased French Bank notes and stocks in the recent dip. There are still attractive yields available, but it is important to be fully aware of the risks and potential outcomes. S&P downgraded France in May (from AA to AA-) primarily because of poor fiscal management (higher budget deficits and debt / GDP ratios). While some French Banks generally have solid fundamentals, further deterioration in the sovereign creditworthiness will have a negative impact. There are ways to optimize your returns within an acceptable risk tolerance. Speak to an advisor to find out how to strategize around this.

Marian Ross-Ammar is Vice President, Trading & Investment at Sterling Asset Management. Sterling provides financial advice and instruments in U.S. dollars and other hard currencies to the corporate, individual and institutional investor. Visit our website at www.sterling.com.jm