3 funds to benefit from falling interest rates: analysis from HL’s Hal Cook

With the ECB having cut interest rates last week, the Fed expected to cut at their meeting tomorrow, plus the Bank of England MPC meeting this Thursday, there’s plenty of speculation in the air about how far and how fast rates might fall from current levels.

With inflation (thankfully) taking a bit of a back seat too, Hal Cook, senior investment analyst, Hargreaves Lansdown, has shared three funds that he thinks look well placed for today’s economic conditions as he comments:

“Headline inflation in the UK, Europe and US is 2.2%, 2.2% and 2.5% respectively. This is no longer high enough to justify keeping rates at current levels. We’ve had rate rises and a period of stable rates at high levels – in the US, rates haven’t been as high as 5% for this length of time since the late 1990s. The next step in the cycle is for rates to come down.

The ECB has recently cut rates for the second time since June. The Fed is expected to cut for the first time this week. The BoE cut in August but is likely to resist a further cut for now. Expectations for the rest of 2024 are for additional cuts from central banks in all three regions, with the biggest cuts expected in the US.

Investors need to prepare their portfolios for rate cuts. Bonds are an obvious choice as their prices are very sensitive to changes in interest rates – as rates come down, their prices usually rise. They have already rallied strongly over the last few months in anticipation of cuts, but likely still have further to go though, especially on a 12-month view. But it isn’t just bonds where value can be found, smaller companies, who may find it more difficult to attract investment or borrow money in a higher rate environment have tended to perform very strongly during rate cutting cycles in the past too.

Funds for a rate cutting cycle

Invesco Tactical Bond is very well placed to take advantage of a rate cutting cycle. They’ve been altering their investments to benefit from rate cuts more recently. This is best illustrated by their duration position which, at around 7 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.

If it’s shares you’re looking at, then smaller companies present an interesting opportunity in a rate cutting environment. Smaller companies have generally struggled during the period of rising rates. This is partly because their revenues can be more linked to the health of the economy and partly because their cost of borrowing is often not fixed. The opposite is true as rates come back down, making them an interesting investment.

Smaller companies in the UK could be a good place to invest, especially with this part of the UK market trading on a significant discount to their larger counterparts. The FTF Martin Currie UK Mid Cap fund is a good option in this space. Richard Bullas has managed the fund since 2013 and is a UK smaller companies’ expert that we hold in high regard.

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 that invest in property and infrastructure. This is largely because one of the key attractions of these trusts is the income that they pay. As interest rates and bond yields have increased, the demand for these types of trusts has fallen because the level of income they pay is not much more than cash or bonds now. This has resulted in a number of them trading at a discount to their net asset value. On a forward-looking basis, this has the potential to reverse and add to the returns of these trusts, however, there are no guarantees.

The Baillie Gifford Sustainable Income fund is a good option in this environment. It’s neutral asset allocation includes around a third invested in infrastructure and property and a further a 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 asset classes, the fund has potential to benefit from them.”

Fund performance

*performance to 31 August 2024 only (latest available data)