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How to prepare for rising interest rates

We are reading lots about rising interest rates but what does it mean for investment portfolios?

Rising interest rates lead to rising costs and decreases in demand. This can hurt the profit of businesses. Companies hurting usually lose value on the share market.^

In this environment, if assets lose value, the banks may ask for more money or assets to cover the debt. It may be more difficult to refinance the loan. When we think about this in our personal lives it becomes clearer. Imagine the value of your home going down to the point where the bank asks for more cash. If you can’t provide the cash either from your own assets or borrowing more money, you will have to sell the home at a lower price and permanently lose the capital you invested in the house.

It is not a pretty picture. So how do you make sure your investments aren’t at risk of permanent loss with tightening credit conditions such as rising interest rates?

The general strategy is diversification, like an index fund, the losses will be covered by the other businesses. But what if the other businesses have debt too? How do you know what level of borrowing the businesses in your portfolio have?

We did some calculations and estimated that of the top 50 companies on the ASX, only 17.5% have enough cash to repay all their loans. Of the top 100 companies on the S&P, only 36.5% have enough to repay their loans.

This means that the majority of these indexes are exposed to interest rate movements and we don’t expect diversification will reduce that risk.

At Valor Asset Management, we think there is a better way than only diversification.

We filter our investments by net cash (more cash than debt). This has resulted in 87% of our portfolio being in companies that hold more cash than total debt. The remaining 13% have enough cash to cover multiple years of debt repayments.

This is like having a home mortgage of $500,000 with $600,000 cash sitting in a bank account. If need be, the home loan can be repaid. The homeowner is not at risk of losing the capital invested in the home due to having to sell to repay.

Our portfolio is the same. In fact, our businesses are positioned to take advantage of company sell offs and be able to increase market share. They could end up in an even better position than before the rise in interest rates.

So how to prepare for rising interest rates? Look at the net cash of your businesses and see if they can repay their debts with ease.*

Alternatively, contact us if you would like to know more about how we can help you prepare.

^ We have not factored in the market movements based on the market psychology of the rate changes, some of which increase share prices, some decrease prices and returns. We acknowledge that this is a simplified view of what happens when interest rates rise. In 2021, we see companies that have no profit with high prices and solid companies with good profit with lower relative prices. We see this as irrational and not sustainable in the long term. Our investment philosophy is about growing capital safely and this article outlines just one of the investment filters we use in building wealth to last.

* The information on this site is of a general nature.It does not take your specific needs or circumstances into consideration, so you should look at your own financial position, objectives and requirements and seek financial advice before making any financial decisions.


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