Steadily rising interest rates are not only a risk for bondholders, but ultimately can have a negative impact on stock prices as they oftentimes signal the end of an economic cycle, says Stefan Meierhofer, the president and CEO of Telos Capital Management.
"We believe that earnings are the biggest determinant of stock prices," and "we do not see current interest rate levels as a reason to abandon equities," he says. Rather, Meierhofer says, investors should apply a tactical approach to stay invested and take advantage of investments that typically perform well during the latter stages of an economic cycle.
Telos Capital also emphasizes equity allocations relative to fixed income in diversified portfolios. "As with any investment, a rising rate environment requires vigilance and diligence, so we believe careful stock selection is key," says Meierhofer.
As for dividend investing, Meierhofer says the firm applies a three-tiered approach: safe dividend payers; dividend growers and high-yield. "In the current environment, we don't own 'high dividend yields' as those securities are seen as bond proxies and will likely lag in this rising rate environment," he says. "Instead, we focus on 'dividend growers' that provide a growing income stream."
Meierhofer also notes that certain market sectors are more sensitive to interest rates than others. "In a rising rate environment, sectors that traditionally carry high levels of debt, such as utilities, REITs and telecommunications tend to underperform," he says. "They have benefited from rising demand due to low interest rates and our exposure to those sectors are currently negligible. We believe that it's important to monitor debt-related financial metrics when researching potential investments."
At present, for instance, Telos Capital Management owns Digital Realty Trust (DLR) in the fast-growing data center REIT industry and Realty Income (O), a retail REIT that just declared the 575th consecutive common stock monthly dividend.
In general, Meierhofer says Telos Capital prefers investing in sectors that have historically performed well in a rising rate environment, such as:
Consumer discretionary: VF Corp (VFC),
Industrials: United Parcel Service (UPS), and
Telos Capital also owns Chevron (CVX).
Another sector that tends to perform well in the early stages of rising interest rates, says Meierhofer, is consumer staples. After their recent selloff, he says a few names start to look interesting: PepsiCo (PEP), Coke (KO), Procter & Gamble (PG), and Sysco (SYY).
"Now these are not necessarily 'safe' investments from a day-to-day point of view but are recommended for longer-term investors," he says. "Moreover, we always stress diversification along with a proper asset allocation."
Meierhofer notes that Telos Capital holds about 30 individual names.
Time to look at CEFs
Dennis Keane, the founder and CEO of the Tottenham Fund, recommends that investors seeking high current income that's relatively safe look at closed-end funds offered by Eaton Vance and Pimco. Some Eaton Vance and Pimco funds that are highly rated by Morningstar include:
Pimco Municipal Income Fund II (PML), daily NAV distribution rate: 6.65%
Eaton Vance Tax-Managed Global Diversified Equity Income Fund (EXG), distribution rate at NAV: 9.75%.
Eaton Vance Limited Duration Income Fund (EVV), distribution rate at NAV: 6.62%.
Eaton Vance Tax-Managed Global Buy-Write Opportunities Fund (ETW), distribution rate at NAV: 9.66%.
Eaton Vance Floating-Rate Income Trust (EFT), distribution rate at NAV: 5.36%.