Few variables shape portfolio returns more powerfully than interest rates – and Toby Watson argues that understanding how different asset classes respond to rate movements is one of the most practically valuable analytical skills an investor can develop.
Interest rate sensitivity is not a single, uniform phenomenon. Different asset classes respond to rate movements in different ways, over different timeframes and through different transmission mechanisms. Investors who treat interest rate risk as a fixed income problem alone are missing a significant portion of the rate exposure that sits within their portfolios. Toby Watson, whose career has spanned senior roles across fixed income, structured credit and multi-asset portfolio management, brings a comprehensive and practically grounded framework to this question – one that is directly applicable to the current environment of elevated and uncertain rate trajectories.
The 2022 rate hiking cycle delivered one of the most dramatic demonstrations in recent memory of how comprehensively interest rate movements affect asset prices across the spectrum. Long-duration government bonds fell sharply, as expected. But so did growth equities, real estate investment trusts and infrastructure funds – asset classes that many investors had not fully assessed for their rate sensitivity. The scale of losses in portfolios that had not adequately accounted for this cross-asset rate exposure was a sobering reminder that interest rate risk is a portfolio-wide consideration. Toby Watson has analysed these dynamics throughout his career and sees rate sensitivity analysis as a core element of serious portfolio construction.
Why Interest Rate Sensitivity Is a Portfolio-Wide Concern
The most intuitive form of interest rate sensitivity is duration – the measure of how much a bond’s price changes in response to a given movement in yields. A bond with a duration of ten years will, all else being equal, fall in price by approximately ten percent for every one percentage point rise in yields. This relationship is well understood by fixed income investors and is routinely managed through duration targets and hedging strategies.
What is less routinely managed is the interest rate sensitivity that sits outside fixed income. Equities, particularly those of companies with high valuations relative to near-term earnings, carry significant implicit duration because a large proportion of their value lies in cash flows expected far into the future. When discount rates rise, those distant cash flows are worth less in present value terms – as the growth equity sell-off of 2022 illustrated with considerable force.
Toby Watson has consistently highlighted this implicit duration as one of the most frequently overlooked sources of interest rate risk in private wealth portfolios. The investors most surprised by the losses of 2022 were often those who had assessed their fixed income duration carefully, while leaving the rate sensitivity of their equity and alternative allocations largely unexamined.
How Should Investors Map Interest Rate Sensitivity Across Their Portfolios?
Mapping interest rate sensitivity across a portfolio requires going beyond duration calculations for fixed income and extending the analysis to the implicit rate sensitivity of equity valuations, real asset cash flows and alternative investment structures. Toby Watson, who developed his analytical framework for rate sensitivity during his years at Goldman Sachs working across multi-asset portfolios and structured credit, has noted that this kind of comprehensive rate mapping requires discipline and the willingness to look at the full portfolio rather than individual asset class silos. Toby Watson sees this holistic approach as one of the more straightforward improvements investors can make to their risk management processes.
How Toby Watson Analyses Rate Sensitivity by Asset Class
Different asset classes carry different forms of interest rate sensitivity. Fixed income instruments carry direct rate sensitivity through duration, with longer-dated bonds more sensitive than shorter-dated ones. Floating-rate instruments – bank loans and many private credit structures – have low or near-zero duration because their coupons reset with reference rates. Toby Watson’s experience at Goldman Sachs, working across structured credit and principal funding, gave him a detailed understanding of how these different structures behave under rate stress – knowledge that shapes how rate risk is managed at Rampart Capital, where he serves as partner.
Equities carry implicit duration that varies considerably by sector and valuation. High-growth, long-duration companies are far more sensitive to rate movements than value-oriented businesses with strong near-term cash flows. This distinction played out clearly in 2022, when growth stocks dramatically underperformed value stocks as rates rose. Toby Watson has argued that this distinction deserves far more attention in portfolio construction than it typically receives, particularly in environments where rate uncertainty remains elevated.
Real Assets and Their Rate Sensitivity Profile
Real assets carry rate sensitivity that is genuine but more complex than that of financial assets. Infrastructure assets valued on discounted cash flow models are directly affected by changes in discount rates. Real estate is similarly affected, both through the discounting channel and through the direct impact of higher mortgage rates on transaction volumes. Toby Watson has noted that the inflation-linkage characteristics of many infrastructure assets provide a partial offset – rising rates often accompany rising inflation, and revenue streams indexed to inflation can partially compensate for the valuation headwind from higher discount rates.
Managing Rate Sensitivity in Practice
Effective management of interest rate sensitivity requires a combination of analytical mapping and active positioning. Toby Watson applies several practical principles at Rampart Capital:
- Duration management within fixed income – maintaining a clear view on appropriate portfolio duration given the rate outlook, and using instruments with different duration profiles to express that view efficiently. Floating-rate instruments serve as a low-duration alternative to fixed-rate bonds in environments where rate uncertainty is high.
- Sector positioning within equities – adjusting the balance between long-duration growth stocks and shorter-duration value stocks in response to the rate environment, recognising that this is a meaningful lever for managing implicit rate sensitivity without reducing overall equity exposure.
Neither adjustment requires precise forecasting of rate movements. What they require is a clear view of the portfolio’s current rate sensitivity and a deliberate decision about whether that sensitivity is appropriate.
Beyond these two primary levers, Toby Watson has identified additional tools that contribute to effective rate sensitivity management:
- Hedging through interest rate derivatives – using swaps or options to modify duration exposure at the portfolio level, particularly when the desired positioning cannot be achieved efficiently through changes to underlying holdings.
- Allocation to real assets with explicit inflation linkage – providing a natural offset to rate sensitivity in scenarios where inflation drives rates higher, rather than relying solely on financial instruments to manage the exposure.
Toby Watson on Rate Sensitivity as an Ongoing Discipline
Interest rate sensitivity is not a one-time analytical exercise. As portfolios evolve and the rate environment changes, the sensitivity profile of a portfolio changes with it. Toby Watson’s approach, developed across decades of navigating rate cycles from his time at Goldman Sachs through to his current work at Rampart Capital, is to treat rate sensitivity mapping as an ongoing discipline rather than a periodic review. For investors serious about managing risk comprehensively, this continuous attention to cross-asset rate sensitivity is one of the clearest ways that analytical rigour translates directly into better portfolio outcomes.
