As investor attention focuses more intently on when the US Federal Reserve will raise interest rates, researchers at Standard & Poor’s (S&P) have warned not to expect a sudden boost for active equity managers.
Rising rates could be expected to exaggerate the difference between companies with high leverage and those with low leverage, as funding debt becomes more expensive, a report from the ratings agency claimed.
“In periods during which rates have increased, there’s no tendency for dispersion to do the same.” —Fei Mei Chan and Craig Lazzara, S&PBut authors Fei Mei Chan, associate director, and Craig Lazzara, managing director, warned that historical evidence has shown little correlation between rising interest rates and an increase in dispersion between the best and worst performing stocks in the S&P 500.
“In periods during which rates have increased, there’s no tendency for dispersion to do the same,” the authors wrote. “Admittedly, rate increases since 1990 have not been nearly as extreme as those of the late 1970s and early 1980s, but the periods of rate increases did not result in higher dispersion as we had conjectured.”
Instead, the opposite was true: Periods in which interest rates rose sharpest coincided with periods of particularly low price dispersion in the S&P 500.
“It may well be that dispersion will increase in late 2015 and 2016; if it does, we would expect more opportunity for active managers to add (or subtract) value relative to their index benchmarks,” Chan and Lazzara said. “But the data give us no reason to assume that rising rates will drive dispersion higher.”
Turning their research to factor-based indexes, Chan and Lazzara found no distinct connections between interest rate rises and the performance of benchmarks such as low volatility or momentum indexes.
The only notable exception was when the researchers paired the S&P SmallCap 600 with the S&P 500. “As rates increase, the margin of outperformance of the small-cap index grows steadily,” the authors explained.
This pattern was “less convincing” when the researchers compared the S&P 500 with the S&P MidCap 400, however.
“So while the evidence may be intriguing, we’re unable to conclude that smaller companies tend to outperform more when rates are rising,” they wrote.
Chan and Lazzara’s full report, “What Rising Rates Will Not Do”, is available on S&P’s website.
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