As discussed in our accompanying piece, despite higher interest rates over the past few years, aggregate net interest costs for large corporations have actually declined, as many were able to refinance debt and lock in the low rates we saw in 2020 and 2021. Looking under the hood, however, higher interest rates haven’t impacted all companies equally.
The chart above illustrates the portion of floating rate debt for both large- and small-cap companies. Unlike fixed rate debt where the interest rate stays fixed for the duration of the loan, floating rate debt has a variable interest rate that fluctuates with the overall level of interest rates in the economy. Consequently, companies with floating rate debt (roughly 36% of debt outstanding for small-cap companies — five times more than large caps) saw the interest cost on their existing debt rise significantly as the Fed hiked rates, while companies with fixed rate debt did not.
Overall, higher interest rates have weighed heavier on smaller-cap companies this cycle, while large caps have been less sensitive to higher financing costs. Given less diversified balance sheets, smaller companies could also face additional headwinds if U.S. economic growth were to falter. Consequently, investors should remain selective when investing in small caps today. However, if interest rates do begin to fall materially, smaller-cap companies should stand to benefit as interest costs will also come down.
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Plante Moran Financial Advisors (PMFA) publishes this update to convey general information about market conditions and not for the purpose of providing investment advice. Investment in any of the companies or sectors mentioned herein may not be appropriate for you. You should consult a representative from PMFA for investment advice regarding your own situation.
