Roland Douglas | Investing in the current low interest rate environment

The massive shock of the coronavirus pandemic and the sweeping shutdowns meant to limit the spread have plunged the global economy into recession. On June 8, the World Bank forecasts the global economy to shrink by 5.2 per cent in 2020. This would represent the deepest economic contraction since the cessation of the Second World War, when the global economy shrank by 10.9 per cent in 1945-46.

As the damaging ripple effect of the COVID-19 pandemic progresses, central banks all over the world have been quick to act in lowering interest rates. However, with rates already sitting at historic lows pre-pandemic, it is possible that banks may be forced to employ more unconventional and controversial techniques to try to calm the economy as time goes on. Also, an important question for many investors is what to do with their cash in the current environment.

Diversify Portfolio

While market experts say there will be a greater shift of interest towards the stock market, the general advice is that investors should opt for a diversified portfolio.

Assets tend to perform differently and the gains of one may offset the losses of another. Accordingly, it is important to consider investments that have different performance drivers as this can reduce the overall risk level of your portfolio. Investments in traditional cash and fixed income may provide income streams largely driven by the level of interest rates. In a portfolio, these investments could be complemented by others in high-quality infrastructure projects or commercial property, where income is instead driven by underlying contracts and lease agreements. Having a variety of different income drivers in this way can help to protect your portfolio’s income stream and reduce your interest rate exposure. A diversified portfolio can still generate positive returns over the long term – although lower than the historical average – that can hold up in an unstable economy. In a nutshell, having a diversified portfolio would mean a more balanced risk versus reward.

For investors that want to expand their scope beyond the stock and bond markets, investing in real estate or unit trusts can help. A unit trust is a form of collective/pooled investment, constituted by a trust deed that can be used to gain exposure to a multitude of investment strategies, including fixed income, equities and real estate or a combination of these. It allows investors to take advantage of investment opportunities that would not normally be available to them as individual investors.

Owning real estate is also a way of creating long-term cash flow and capital appreciation for investors. However, owning real estate requires a large upfront capital investment, can be illiquid and has its unique set of risks. This is where investment trusts, known as REITs, come into play. These can offer higher returns for long-term retail investors saving for retirement through high dividend yields and capital appreciation and is a more affordable way of gaining exposure within the real estate industry. REITs can serve as a diversifier in your investment portfolio since it is an uncorrelated asset to equities. Also, since low interest rates filter through the monetary mechanism and eventually drive higher inflation, real estate investing serves as an inflation hedge and provides tax benefits in the long run.

Catalyst for Economic Growth

Also, like many economic indicators, the low interest rate environment for personal and corporate borrowing can serve as a catalyst for economic growth through increased borrowings. Notwithstanding, this can be deterred by the current economic landscape as there is still an unusual amount of uncertainty in the air where jobs and incomes are concerned.

We expect the low interest rate environment to persist as monetary policy remains accommodative to jump-start an economic recovery. While today’s low interest rate environment creates some challenges for investors looking for adequate returns through bonds, it may provide an opportunity for corporate borrowers and equity investors. With this in mind, we encourage investors to remain defensive and vigilant. We encourage investors to also gain exposure to United Stated dollar-denominated instruments with relatively low risk profile, as a hedge against a depreciation of the Jamaican dollar.

Roland Douglas is a Research Analyst at Victoria Mutual Wealth Management Limited.