Investing for lower interest rates

Elsewhere, opportunity knocks for investment trusts invested in assets that tend to perform more strongly when rates are coming down. The Association of Investment Companies (AIC) surveyed analysts about trusts and sectors they thought would do well in an environment of falling rates and three asset classes stood out in particular – and in each case, investment trusts are really the only practical way for most retail investors to access these areas.

First, investment trusts that invest in the infrastructure sector could now offer more value. This is largely because of the way financial markets value the long-term assets held by funds in this sector – everything from physical infrastructure such as roads and utilities to digital assets including IT networks. The prevailing interest rate is a key consideration here; when rates fall, the value of longer-term assets rises because it becomes harder to secure shorter-term returns from investments such as bonds. Funds holding longer-life assets such as water, energy and transport should get the most significant benefit.

Investors could also take a closer look at the renewable energy industry – a subset of the infrastructure sector in some ways, but an area of interest for a number of specialist investment trusts. Renewable energy assets benefit from the same valuation impact as other types of infrastructure when interest rates fall. But lower borrowing costs also make it easier for developers to finance new projects, boosting growth in the clean energy sector. It’s also worth noting that renewable energy projects are often backed by government guarantees of long-term demand – important to incentivise investment in the industry – which gives investors good visibility of future returns.

The second interesting area is property. Falling interest rates bring down borrowing costs and therefore increase demand for real estate; all other things being equal, that should be good for prices. Remember too that unlike other types of collective investment fund, investment trusts are allowed to borrow money to invest; those that do so could now benefit from lower debt costs. Indeed, real estate investment trusts holding variable-rate loans may be in for a double whammy of positives – capital appreciation on their assets and reduced interest charges.

Third, but not necessarily least, falling interest rates tend to benefit “growth assets” – that is, investments expected to deliver outsized returns in the future, rather than lots of jam today. Privately owned, early-stage companies are a good example; the fact they don’t generate significant returns right now is less of a problem when more traditional assets aren’t paying so much either. Private equity-focused investment trusts, as well as a number of funds in the Growth Capital sector, are a good place to look for exposure to these assets.

All of which suggests investment trusts could throw up some interesting opportunities as the Bank of England governor’s expectations come to fruition over the coming months. All the more so given that shares in many funds in these areas currently trade at unusually wide discounts to the value of their underlying assets.