Ahead of the impending rate hikes in the US, George Boyd-Bowman, manager of the Neptune Global Income Fund comments on the risks facing defensive, dividend stocks that investors have relied on in recent years.
Bond proxy stocks have thrived in the ultra-low interest rate environment, but in a rising interest rate environment their attractiveness is significantly reduced.
Looking at the valuations of these companies, especially relative to other parts of the market, I do not believe these risks have been priced in accurately. This has created a real complacency among investors who have benefited from bond proxy stocks in recent years.
The Neptune Global Income Fund has a preference towards quality cyclical companies that are less at risk from rising interest rates. Indeed, rising interest rates suggest the US recovery is gathering momentum, which should benefit these companies.
One sector which should benefit from higher interest rates, and one that I have been initiating positions in, is US banks. They have been crippled by low rates for the last few years and seem to finally be putting regulatory issues behind them.
In addition, loan growth is now looking encouraging and if the regulators are increasingly happy with their capital levels then it bodes well for strong dividend growth over the next few years. Valuations at their current level are also very attractive.
Some still believe US banks are fundamentally risky, thanks largely to memories of the financial crisis, but there is a strong case that the defensive bond proxy stocks that have served investors so well in recent years carry greater risk in the next stage of the cycle.