Investment Risk: Higher Rate Drivers

Institutional investors often assume a degree of “return-to-normality” for long-term rates in their investment plans. But what are, if any, the preconditions for return to higher interest rates? And if those preconditions are not met, what could be the expectation range that takes into account the structural drivers of interest rates?

The fortunes of pension funds at least on paper depend on the level of long-term (real) interest rates. Despite new all-time highs in equity prices, pension funds are not keen to celebrate so long as the rates remain subdued and the net present value of liabilities remains high.
Our conventional “classical” understanding of business cycles suggests that there should be a positive correlation between long-term interest rates (bond yields) and equity markets: as the aggregate demand picks up, so does the long-term GDP growth rate and finally – interest rates. This understanding however falls short of explaining the secular decline in long-term interest rates observed in most of the developed markets.


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