Recently a senior citizen took out Rs. 15L from his mutual funds and invested it in an LIC pension plan. When his son in law asked me…I said…”It does not matter”. The son in law was surprised because I had warned him against EXACTLY THIS TRANSACTION in the previous week. I said “not suitable for you, but fine for your 83 year old father in law”. Rising interest rates will make this product look bad. Really bad. However for a 83 year old inflation may not be a problem and re-investment risk (2028) may not be a material risk either. He will get an annuity till age 93 and then a lumpsum which could be used for the rest of his life without worrying about interest rates and inflation.

What happens when interest rates go up? I see it inching up since the last quarter of 2017. In fact the market is taking its cues from the US Fed. Many central banks will have to raise interest rates – the real fear is that of a cash going to the US market. However, your Central bank governor will say “we are worried about inflation”. Well impact is the same.

One thing is certain. The equity leaders will change. Industrials like Cummins, Siemens, LnT, will do well. This is not because interest rates are increasing, but because the underlying economy is doing well. When the economy does well and there is demand for goods – cash, cars, houses, which sectors will do well? It has to be banks. Banks which lend to the industry, not just retail bankers. So it is SBI and Icici banks which will do better than Hdfc, Indusind and Kotak (beware I may have a position – put or call). Banks increase lending rates much faster than increasing rates for depositors. So banks with a high CASA will improve NIM very fast as compared to those who depend on wholesale funds.

Utilities should do badly – but given Indian conditions our electricity utilities and phone utilities are anyway not doing too well in the markets so it may not matter.

While interest rate changes affect certain sectors more than others, no two cycles are the same. As such, one potential “trap” for equity investors is to make assumptions that are too broad, expecting short-term shifts in sector leadership that may not play out as expected. Investors can benefit by taking an active view within sectors — analyzing the specific impacts for a particular business or industry in the current cycle. This requires some active information seeking – like finding out which industry is borrowing at a rate higher than what the banks are willing to lend at. I can imagine the steel sector gasping for cash – given our payment cycles.

As a long-term view beyond the rate cycle also provides important perspective. While mindful of the potential of macro drivers such as interest rates to steer markets both up and down, as a person managing my own portfolio, I am more worried about commodity cycles. I will not be in a hurry to buy sugar, nor am in a hurry to sell off the steel. Yes I might buy JSW steel and sell off Tata steel – but this is just a call on the management not on the interest rate cycle (Ok I may have a position in both, or a put in one and a call in the other, don’t copy please). I am more a bottom up stock picker – but yes utilities may not be my favorite in a rising interest rate scenario. I expect the companies that I hold to be able to pass on the rising int rates (it is a factor of production) and not worry too much about its impact on the bottom line. Of course I could be wrong – buy hey, I will be watching.