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The low interest rate environment

Over the past years, the wave of economic weakness, primarily following the recession way back in 2008, has led major Central Banks to take action by deploying certain measures in an attempt to trigger an economic recovery.

To this extent, following the recessionary period, in order to propel inflation higher and thus ultimately economic growth, Central Banks had lowered interest rates to low levels.

However, what are the implications of such monetary easing? In my view, the impact is twofold. The monetary decision of lower interest rates has an impact on both the consumer and corporations.

From the consumer perspective, the low interest environment has offered the opportunity for many to borrow at lower rates. However, it is important to note that such monetary decision is not an imposition on consumers, but solely an opportunity.

This is one of the reasons, why the economic recovery might take a prolonged period, as many still fear another downturn. Consumers might primarily opt to save more, rather than borrow and spend.

In this context, the savings rate preposition is an important aspect when looking at the macro environment, as this differs across geographical areas. Case in point are the differentials experienced in the US when compared to the Eurozone area.

The former savings rate is currently at 2.4%, while the latter is currently at lows of 12.02%. Thus, the perception of the economic trends has indeed an impact on people’s perceptions. In all fairness, over the years we did see a pick-up in inflation triggered through consumer demand.

However, what’s more interesting is how this low yielding environment affected corporations. Looking at the high yield bond market, the low interest rates have offered huge opportunities to many companies to re-finance at lower rates, and thus save on interest expense at the detriment of investors.

The more interesting bit is the fact that through low interest rates, companies restructured their balance sheets, and now they have a healthier balance sheet.  In fact, fundamentally those who managed to restructure have now more strong and disciplined balance sheets.

Looking at key metrics as per industry practice, we have seen a major improvement across the board. For instance, leverage metrics, a measure of debt vs earnings being generated, prior to interest and tax payments, are at lows of 3.8x versus the highs experienced in 2010.

Likewise, interest coverage, a metric that shows the company’s ability to pay its interest payments, is at highs of 2.4x as opposed to the lows of 1.4x way back in 2009. Furthermore, the generation of cash flow to debt has also improved drastically.    

From a bond picking and portfolio management perspective, throughout 2016-2017 I have seen a wave of companies re-financing at much lower rates, which obviously affected the ability of a portfolio manager such as myself, to generate the high returns, which were previously being generated.

From an Investment Manager’s perspective, more sanity in balance sheets is undoubtedly a positive. That said, in my view, many companies who have taken the opportunity to re-finance at lower rates, are still not paying investors a decent rate of return given the specific risks they carry.

Ultimately, despite a low interest rate environment, being an important monetary tool to stimulate economic growth, its repercussions might at times put investors at a disadvantage from a risk-reward perspective. It is imperative that prior to investing, the risks versus the returns are analysed. Do not be fooled, don’t let companies take advantage of the low interest rate environment at your expense.    

Disclaimer: This article was issued by Jordan Portelli, Investment Manager at Calamatta Cuschieri. For more information visit, www.cc.com.mt. The information, view and opinions provided in this article is being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice.

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