Interest rate fund and trust losers stage a recovery – but will it last?

Hopes that interest rates around the world have peaked and central banks will begin cutting rates this year have sparked a dramatic stock market rally over the past two months, concentrated among the biggest losers when interest rates rose throughout 2022 and early 2023.

Real assets (such as physical property and renewable energy infrastructure), cryptocurrency, technology, biotech and smaller company funds and investment trusts, have all led the performance tables since 1 November 2023, when the market rally began.

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Some strategies have risen as much as 60% in just over two months, while more than 70 funds, exchange-traded funds (ETFs) and investment trusts are up more than 20%, according to total return data from FE Analytics.

The top investment trust sectors over this period include Property Securities (up 27% on average), Growth Capital (up 20%), North American Smaller Companies (up 19.5%), European Smaller Companies (up 16%) and Biotechnology & Healthcare (up 13.5%).

Top fund sector winners over the same period include: Technology & Technology Innovation (up 11.5%), North American Smaller Companies (up 13%) and Healthcare (up 10.5%).

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The market rally was linked to messaging from central banks, with US Federal Reserve chair Jerome Powell signalling in December that US interest rates could be cut three times in 2024 and that interest rate rises were over.

Markets pre-empted the messaging and began rallying before the explicit signal from the US central bank.

Traders are pricing about 1.5 percentage points of rate cuts in the US and UK in 2024, and around 1.7 percentage points of cuts in the Eurozone, according to Bloomberg.

These forecasts are being spurred by rapidly falling inflation, with annual price rises at just 3.9% in the UK and 3.1% in the US for November 2023.

Lower interest rates are great news for two types of stock market assets: those that compete with the bond market for income, as bond yields fall when rates fall and make them less attractive to income investors; and investments that are “long duration”, meaning that the profits are expected to come a long way into the future, such as high-growth technology stocks.

This explains the basket of funds and investment trusts that have performed exceptionally well in the past two months.

Technology and growth company funds that are leading the charts over this period include: Schiehallion Fund (up 59.5%), Baillie Gifford US Growth Trust (up 27.5%), Nikko AM ARK Disruptive Innovation (up 32%), Augmentum Fintech (up 32%), Seraphim Space Investment Trust (up 27.5%), Chrysalis (up 26.5%) and Baillie Gifford American (up 21.5%).

Real asset winners include: Tritax Eurobox (up 32.5%), Gore Street Energy Storage (30.5%), JLEN Environmental Assets Group (25.5%), TR Property (up 24.5%), Xtrackers FTSE Developed Europe ex UK Real Estate UCITS ETF (up 24%) and abrdn European Real Estate (up 21%).

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Crypotcurrency winners include: WisdomTree Blockchain UCITS ETF (up 62.5%), HAN ETC Group Digital Assets & Blockchain Equity UCITS ETF (up 51%), HANetf Grayscale Future of Finance UCITS ETF (up 48%) and Invesco CoinShares Global Blockchain UCITS ETF (up 34.5%).

Rather than being a hedge against inflation, crypto prices have been more closely linked to interest rates, with rising rates bad for prices and falling rates positive for the asset class. Bitcoin has risen from $29,100 on 1 November to nearly $34,000 today.

Smaller company winners include: Henderson Smaller Companies (up 25%), Edinburgh Worldwide (up 21.5%), Xtrackers Russell 2000 UCITS ETF (up 16%), JPMorgan US Smaller Companies (up 23%) and JPMorgan UK Smaller Companies (up 21%).

Biotechnology winners include: Pictet Biotech (up 27%), Polar Capital Biotechnology (up 22%) and Biotech Growth Trust (up 20%).

These winning funds all struggled during a rising interest rate environment, with investment trust discounts widening and adding to the pain for some investors.

Will the strong returns continue?

Investors are beginning to form a consensus that there will be a “goldilocks” scenario in 2024, with inflation falling towards the 2% central bank targets without higher interest rates leading to recessions.

This has been the basis for the strong rally in interest-rate sensitive shares, but Neil Birrell, chief investment officer at Premier Miton, tells investors not to get “overexcited”.

Birrell says there is a risk that the best expectations for falling interest rates are not met.

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He said: “Inflation may not fall as hoped or economies may stay stronger than thought, which could result in some of the recent gains being given up.

“Furthermore, financial markets rarely move in a straight line, one way or the other, so it is unlikely to be a smooth path, but as it stands, the outlook is more positive than it has been for some time.”

On top of macroeconomic factors, markets in 2024 are likely to be heavily influenced by politics – there are elections in more than 50 countries, including the US, UK and India, covering countries with more than two billion people.

“This will obviously bring change within each country and region, but it could also be formative for global geopolitics and the global economy, with the US probably being the most influential, depending on the outcome of its election,” Birrell adds.