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What does the Bank Rate rise mean for your investments?

Holly Black
Investing in emerging countries, such as Brazil, could offer good protection against rising interest rates - Getty Images Contributor

The Bank of England has raised Bank Rate to 0.5pc - its first rise since 2007 - leaving investors wondering what it means for their portfolios. 

Seven of the nine Monetary Policy Committee members voted in favour of the increase, sparking a flurry of activity across investment and currency markets. 

With interest rates having been at rock-bottom lows, many have positioned their investment portfolios to reflect that. But if the tide has turned, and interest rates are going to continue going up, which investors will it affect?

Anthony Gillham, the head of multi-asset funds at Old Mutual, said: "Everything - from bonds and equities to currency - has become very dependent on what the central bank does."

So what does the Bank Rate rise this week mean for investors?

Battle of the bonds

This asset class has been incredibly popular since the financial crisis because bonds pay a set level of income - an appealing characteristic in times of uncertainty.

When Bank Rate is at a rock bottom of 0.25pc, by comparison a yield of 1pc from a government gilt seems attractive. However, if interest rates start to rise, that income stream starts to look less attractive. Many investors will find they have locked into a negative return in real terms.

But any rush to the exit might be a buying opportunity. If investors rush to sell, prices would probably fall, forcing the yield up. While that's bad for sellers it could be a good time to buy, especially if the market settles and the yield reverts to where it was previously.

Mr Gillham said: "We're not going to sell all our government bonds, there is a place for them in investment portfolios. Gilt yields climbed around 0.3pc on talk of rate rises, so it could be a good tactical opportunity to buy some."

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Investing in a strategic bond fund, where the fund manager has the freedom to invest in a mix of quality, high-yield and government bonds, is a good way of lowering risk.

Experts we regularly consult like Artemis Strategic Bond, whose managers decide where to invest by analysing factors such as interest rates, inflation and the credit rating of the bond. It has returned 17.5pc over three years.

Timing is everything

How quickly interest rates rise is key to what investors should do to prepare. A gradual raising of rates, which is expected, should not hurt the stock market but steep hikes could spark a major correction.

Simon Evan-Cook, manager of the Premier Multi-Asset Global Growth fund, said rates rising significantly was a threat that could see investors flood out of the market in favour of the safety of cash.

He said: "If you can earn 5pc on cash in the bank then it's not as tempting to take the risk of investing in equities."

The assets most likely to be hit in this scenario are those that have performed exceptionally well since the crisis. That includes so-called "bond proxy" stocks - the quality blue-chip companies that have paid a steady dividend over recent years.

Mr Gillham is looking to firms that haven't had a good time but whose business models can benefit from higher interest rates, such as banks. They have spent years getting their house in order, so should benefit from rate rises.

Hunt globally

With so much uncertainty in the UK, many professional investors are looking elsewhere.

Anthony Rayner, co-manager of the Miton Cautious Multi Asset fund, which invests across a range of asset classes and countries, said: "The UK is too difficult: at the moment we have very little there.''

The fund, which returned 28.4pc in the past three years, has just 7.6pc of its assets in UK stocks. Mr Rayner likes Brazil, where falling interest rates are boosting consumer spending, and India, where strong demographics are driving growth in consumer companies and banks.

Mr Evan-Cook thinks equities outside America are attractive. "As long as you take a long-term view and accept there will be bumps along the road, you should make decent returns from equities in Europe, Japan and Asia."

Mr Rayner likes trends such as the rise of the electric car, which he taps into through Chinese tech firms, and the ageing population, which he backs through medical device firms.

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How significant is the change?

The Bank reduced interest rates last summer, when the base rate was halved to 0.25pc after the result of the Brexit referendum. The increase has only reversed that move. 

Andrew Moffat, co-manager of the Marlborough Extra Income fund, explained: "We are not changing our investment strategy. The Bank doesn't want to go into the next downturn with interest rates at zero but I don't think rates will rise significantly."

Others say high inflation - the main reason a rise was called for - has been caused by the weak pound rather than prices of food or clothing rising. Sterling made a lot of ground just on talks of a rate rise, but fell against both the dollar and euro immediately following the Bank of England's decision. 

However, if sterling does ultimately continue to strengthen, that could be a problem for the 70pc of earnings in the FTSE 100 index that come from overseas.

Mr Gillham said: "Moving into smaller and medium-sized companies, which are more domestically focused, might be a better option."