Try to hide wherever you like but periods of rising interest rates mean lower returns.

The Federal Reserve raised rates for the first time in more than nine years in December, and seeing as short rates are at 0.50 to 0.75 percent, investors may be facing an extended and potentially steep trip to higher levels.

For many investors, especially those in their 20s or 30s, this may well be their first time trying to maximize returns during a tightening cycle.

A study from researchers at the London Business School looks at more than a century of easing and tightening cycles and concludes that inflation-adjusted returns will be lower as the Fed takes rates higher.

“It is hard to identify assets that perform well in absolute terms during hiking cycles, although we do detect relative outperformance at such times from defensive vs. cyclical stocks and from large-cap vs. small-cap stocks,” the researchers write.

In inflation-adjusted terms all major financial assets and all principal real assets, like farmland and precious metals, perform less well when rates rise vs. when they are falling.

In inflation-adjusted, or real terms, U.S. equity investors have made 6.2 percent annualized since 1913. When rates were falling that annualized return is 9.3 percent but when they are rising it falls to 2.3 percent.

For U.S. bonds, real returns over the period were 2.2 percent, with a 3.6 percent return when rates were falling and just a 0.3 percent return when they are rising.

Real assets also do worse when rates are rising despite often being thought of as a shelter from inflation. The study looked at 11 real assets, from violins to real estate to wine, and found that every one did better during periods of easing.

Within equities the study did find the expected difference among sectors, with those thought to be cyclical offering a return levered to economic growth, differing sharply from those which are defensive and have more stable growth. For example, healthcare stocks, a classic defensive sector, have outperformed the broad index by 4.5 percent annualized since 1926 during rising rate periods but have lagged slightly when rates are falling. Retail, a cyclical sector, outperforms the index by 3 percent annualized during periods of falling rates but lags by 2.1 percent when rates rise.

To be sure, diversification still has benefits during periods of rising rates, but it isn’t a magic bullet during tightening cycles. History, as they say, could be different this time, but investors ought not to bet on it. Returns will be lower and we should all plan accordingly.


James Saft is a Reuters columnist.