Lower interest rates are not a cyclical phenomenon but are more permanent and carry major implications for investors, claims UBS Asset Management.
The firm says many of the drivers for the fall in long-term interest rates are not cyclical, as previously assumed, but structural.
The asset manager also says this fundamental downward shift in “equilibrium” rates has not been factored into capital markets.
In a paper entitled Disequilibrium, UBS AM describes the long-term equilibrium interest rate as the nominal rate, adjusted for inflation, at which the capital supply in an economy precisely meets capital demand to keep growth and inflation stable.
This rate, says the firm, has seen a fundamental shift downwards due to factors such as population growth – which, for example, is set to reverse in both the US and China, putting downward pressure on the natural rate of interest rates; ageing populations, which increases demand for safer, income generating assets; and bank deleveraging has led to lower lending growth, lower capital investment and lower economic forecasts – and therefore lower long-term interest rates.
There are two implications for investors, the paper says. Lower long-term equilibrium rates have significant implications for future monetary policy with the possibility of further unconventional policy measures raised. Secondly, investors with a required rate of return – such as pension funds – will be impacted and may need to consider the suitability of investments.
UBS AM says investors should adopt a more unconstrained approach to their investment universe, and increase flexibility around strategic asset allocations.
Investors should also focus on managing downside risks by being “nimble, flexible and liquid” and seek to understand the benefits of diversification at a risk-factor level.
Dawn Fitzpatrick, global head of equities, multi-asset and O’Connor, at UBS AM, said: “We believe that an understanding of the long-term equilibrium rate of interest and its actual level is crucially important if we are to obtain a clear picture of the true implications of this low-yield environment. Critically, a lower long-term equilibrium interest rate means that expected returns fall for all assets across the risk spectrum while expected risk stays the same.”
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