Interactive Investor: Interest rate-sensitive funds come roaring back in market rally

A potential end to monetary tightening has ricocheted rate-sensitive funds back into vogue

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Funds and trusts that were battered by rising interest rates have come bounding back over the past two months now that potential rate cuts are on the horizon, according to interactive investor.

Portfolios investing in technology, smaller companies, real assets, biotech and cryptocurrency were fighting against monetary tightening for much of the past two years, but investor sentiment has improved considerably since the US Federal Reserve signalled an end to hikes in December.

It also suggested that there could be up to four rate cuts in 2024, which was the catalyst for a “significant comeback among major underperformers”, according to Sam Benstead, deputy collectives editor at ii.

These assets may have been most vulnerable to rising rates, but hinted cuts down the line have painted a more positive outlook for two types of equities, Benstead said.

“The first is those in competition with the bond market for income, as bond yields fall when rates drop, making bonds less attractive to income investors,” he explained.

“Second, investments classified as ‘long duration’, indicating profits are expected in the distant future, particularly high-growth technology stocks. This sheds light on the recent exceptional performance of a variety of funds and investment trusts over the past two months.”

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Interest rate-sensitive sectors such as IT Global Smaller Companies, IT Biotechnology & Healthcare and IT Technology & Technology Innovation plummeted 20.8%, 10.5% and 8% from when the Fed started hiking rates in March 2022 to when the recent rally began in November 2023.

Since sentiment began to improve two months ago, however, those sectors rebounded 14.4%, 11.7% and 11.3% respectively.

Of the funds highlighted by ii, the WisdomTree Blockchain UCITS ETF was the greatest performer of the recent resurgence, climbing 62.5% since the start of November.

The $2.2m cryptocurrency fund spent much of the Fed’s hiking cycle in negative territory, dropping as far as 52.6%, but an improved monetary outlook has returned some confidence to the interest rate-sensitive asset class.

Other crypto-related funds such as HAN ETC Group Digital Assets & Blockchain Equity UCITS ETF, HANetf Grayscale Future of Finance UCITS ETF and Invesco CoinShares Global Blockchain UCITS ETF have also seen improved performance since November, climbing 51%, 48% and 34.5% respectively.

Also leading the recent rally were tech and growth capital portfolios, with the likes of Schiehallion, Baillie Gifford US Growth, Nikko AM ARK Disruptive Innovation and Augmentum Fintech soaring 59.5%, 27.5%, and 32% each for the latter two funds since November.

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Nevertheless, some of these funds still have some way to go before fully recovering from their losses over the past two years.

The Schiehallion fund, for example, may have outshone its peers in the recent optimism-filled rally, but returns are still down 58.2% since the Fed’s hiking cycle began in March 2022.

Similarly, Baillie Gifford US Growth stormed ahead of its peers in the IT North America sector since November, but still trails behind them since rates began rising. It is down 20.3% since March 2022 whilst the average fund in its peer group is up 4.3%.

Both the Schiehallion and Baillie Gifford US Growth are on discounts of 36.3% and 14.1% respectively, which could be an appealing entry point for investors who think the rally could persevere through into 2024.