Does value investing make sense in a rising interest rate environment?


When interest rates begin to rise, value becomes a better investment strategy because the decline in value is limited compared to the decline in growth.

In short, it’s all about value investing – where investors give preference to companies that have low valuations relative to their intrinsic value, have decent cash flows in their businesses and, in some cases, which have a high dividend yield.

With interest rates currently rising globally, as central banks focus on containing high inflation, some experts say it’s time to invest in value again.

“High inflation means a high cost of capital. The latter implies that companies that derive value from short-term cash flows are less affected by any increase in the discount rate than those that derive value from long-term cash flows,” said Meenakshi Dawar, fund manager, Nippon Life India Asset Management Ltd.

Dawar believes there is now a strong case for value investing, as the earnings of the past two or three years have become more widespread.

“The high growth premium that few companies have gotten should shrink from here. In addition, high inflation and a high cost of capital favor value companies,” the expert said.

The period of high inflation can be beneficial for specific sectors and stocks. According to experts, inflation leads to an increase in the cost of raw materials, among other things.

“Companies able to pass on the impact of this price increase to their consumers will fare better. The same is true for companies with access to low-cost capital than those who borrow money at a higher cost,” said Mayukh Datta, Head of Product Strategy and Communications, Mirae Asset Investment Managers (India) Pvt. ltd.

“For example, banks that don’t raise term deposit rates in line with their lending rates may do well if their margins increase. Energy companies can fare well as customers need energy products for their own consumption or to run their plants and plants, even as energy costs rise. Agricultural products can benefit as companies pass the costs on to their customers,” Datta said.

Meanwhile, Dawar believes companies that are producers will do better than those that are consumers. “For example, sectors such as metals, agricultural producers, energy, construction materials, chemicals, etc., will have a direct correlation of income with higher inflation,” Dawar said.

Moreover, if inflation is due to a better recovery in demand, there is a broad base of market returns, which means that sectors such as industrials, infrastructure, real estate, etc., have tend to do better.

Since the start of the year, Sensex and Nifty are down 10%, while the S&P 500, which is a broad index representing 500 companies listed in the United States, is down about 19% on the same period.

Overall, valuations have fallen at many companies. As stock markets have become cheaper, experts say you can’t rely solely on value investing.

Investors need to ascertain the reasons for falling company valuations and then make an informed decision, they add.

Regarding the growth versus value debate, Kirtan Shah, Founder and CEO of Credence Wealth Advisors, said, “Investors should always stick to their asset allocation because nine out of 10 people might not be able to time the market. However, for people who understand the markets, value can make a lot of sense today. Ideally, as a retail investor, you should have both value and growth in your portfolio.”

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