Historically, there have been investment strategies that outperform in a higher rate environment. These have included international stocks, commodities and certain kinds of real estate. Some may even consider cash in this bucket since rising interest rates are reflected in higher nominal returns for guaranteed investment certificates and other term deposits.
Two investment strategies to consider with the aim of generating positive real returns are merger arbitrage and small-cap funds. Higher interest rates are directly connected to merger-arbitrage spreads because investors demand a higher rate, one above the risk-free rate , to hold the shares. In this way, merger-arbitrage funds are an inflation hedge and the returns are uncorrelated to the general direction of equity and bond markets. As spreads widen, potential returns increase.
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