With the economy roaring back to life, the Bank of England has revealed that interest rates are set to begin rising later this year. This is great news for savers, who have been struggling with rock-bottom savings rates for some time now.
However, for investors, rising interest rates could bring about some unwanted consequences.
Rates up, prices down 
Most investors will be aware that as interest rates rise, bond prices fall, but many investors also fail to realise that rising interest rates will have the same effect on stock prices.
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According to financial data company Morningstar, it has been found that over the past few decades, defensive companies — with bond-like qualities — have seen their share prices fall as interest rates rise. On the other hand, Morningstar has found that the share prices of cyclical companies will rise when interest rates rise.
Morningstar picks out slow-growth, defensive companies with high dividend payouts, like British American Tobacco (LSE: BATS) and Unilever (LSE: ULVR), as the companies that are most likely to see their share prices fall when interest rates rise.
That being said, Morningstar has also found that cyclical companies, such as BHP Billiton (LSE: BLT) and Royal Dutch Shell (LSE: RDSB), tend see their share prices rise in line with interest rates.
No reason to worry
So, is it time to swap your holdings in Unilever and British American Tobacco for BHP Billiton and Shell following this news?
Well, due to their defensive natures, I think both Unilever and British American deserve a place in any portfolio. What’s more, at present Unilever offers a dividend yield of 4.1%, with the payout being covered one-and-a-half times by earnings per share. It’s going to be a long time before interest rates rise enough to rival this yield.
Similarly, British American’s shares are currently supporting a dividend yield of 4%, once again covered one-and-a-half times by earnings per share. As an investment, British American will remain attractive long after interest rates start to rise, as the company’s earnings are expected to rise at a high single-digit percentage over the next few years.
Going cyclical
Still, it’s never a bad idea to be prepared, and if you’re looking to profit when interest rates start to rise, both Shell and BHP make great picks.
Shell is a dividend champion. The company currently supports a dividend yield of 4.2%, which is expected to hit 4.4% next year. These payouts are covered by around one-and-a-half times by earnings per share. Further, at present levels Shell’s shares look cheap. The company is trading at a forward P/E of 11.5.
Then there is BHP. At first glance, BHP’s lowly dividend yield of 3.3% is not much to get excited about. However, the company is planning to spin off its ‘Billiton’ part of the business some time over the next few months, which is likely to mean a hefty cash return for investors. The company’s dividend yield is set to hit 3.5% next year, above the FTSE 100 average of 3.4%.
If you can’t decide 
If you can’t decide between BHP, Shell, Unilever and British American Tobacco, there is another choice: Lloyds (LSE: LLOY). Lloyds, as a bank, will be able to navigate the rising interest rate environment better than most. Indeed, rising rates will allow the bank to charge customers more to borrow.
In addition, according to my figures, if Lloyds is allowed to recommence its dividend payouts to investors then the bank’s shares could yield up to 7%!
For example, if Lloyds does get the go ahead from regulators to restart dividend payments, City experts believe that the bank will return around 70% of income to investors.
If City predictions prove true and the bank does hike its payout ratio to 70%, then with earnings of 8p per share forecast for 2015, Lloyds could offer a dividend payout of 5.6p per share, a yield of around 7.1%.
