5 ETFs Set to Benefit From Higher Rates
The Federal Reserve, as expected, raised interest rates by 75 bps for the fourth consecutive time. This is the sixth rate hike this year, a streak that has made mortgages and other consumer and business loans increasingly expensive and heightened the risk of a recession.
Against this backdrop, many ETFs from various corners of the market are poised to benefit from a rising-rate environment. Some of these, like SPDR S&P Insurance ETF KIE, SPDR S&P Regional Banking ETF KRE, Vanguard Value ETF VTV, JPMorgan Ultra-Short Income ETF JPST and iShares Floating Rate Bond ETF FLOT, seem compelling picks.
The rate hike brings the benchmark interest rate, the federal funds rate, to 3.75%-4%, its highest level since 2008. The increase in interest rates has made borrowing expensive, pushed up the cost of buying a new car or house, increased the cost of carrying credit card debt and thus slowed down economic growth (read: Is the Party Over for Housing ETFs?).
The central bank also signaled that future increases in borrowing costs could be made in smaller steps to account for the “cumulative tightening of monetary policy” it has enacted so far.
Any Reason to Worry?
Higher rates would attract more capital to the country, thereby boosting the U.S. dollar against the basket of other currencies. However, since a strong dollar should have a huge impact on commodity-linked investments, a rising-rate environment will also hurt a number of segments.
In particular, high dividend-paying sectors such as utilities and real estate would be the worst hit, given their higher sensitivity to rising interest rates. Additionally, securities in capital-intensive sectors like telecom would also be impacted by higher rates.
ETFs That Set to Benefit
Insurance stocks are among the prime beneficiaries of a rate hike, as these are able to earn higher returns on their investment portfolio of longer-duration bonds. But at the same time, these firms incur loss as the value of longer-duration bonds goes down with rising interest rates. Nevertheless, since insurance companies have long-term investment horizons, they can hold investments until maturity and hence, no actual losses will be realized.
SPDR S&P Insurance ETF follows the S&P Insurance Select Industry Index, holding 50 stocks in its basket, with each firm accounting for no more than 2.7% share. About 46% of the portfolio is allocated to property and casualty insurance, while life & health insurance and insurance brokers round off the next two spots with double-digit exposure. SPDR S&P Insurance ETF has managed $527.1 million in its asset base and trades in a good average daily volume of about 1.3 million shares. The product has an expense ratio of 0.35% and a Zacks ETF Rank #2 (Buy) with a Medium risk outlook.
As banks seek to borrow money at short-term rates and lend at long-term rates, the rise in interest rates will help them earn more on lending and pay less on deposits, leading to a wider spread. This will expand net margins and increase banks’ profits.
SPDR S&P Regional Banking ETF provides exposure to the regional banks’ segment by tracking the S&P Regional Banks Select Industry Index. It holds 143 stocks in its basket, with each accounting for no more than 2.3% of the assets. SPDR S&P Regional Banking ETF has AUM of $3.5 billion and charges 35 bps in annual fees. It trades in an average daily volume of 7.6 million shares and has a Zacks ETF Rank #1 (Strong Buy) with a High risk outlook (read: 5 Sector ETFs That Could Flourish in November).
Higher yields indicate optimism in the economy backed by increased consumer confidence, rising wages and higher spending. This combination of factors will result in increased industrial activity and a pickup in consumer demand, thereby lifting value stocks.
Vanguard Value ETF targets the value segment of the broad U.S. stock market and follows the CRSP US Large Cap Value Index. It holds 344 stocks in its basket, with each accounting for less than 3% of assets. Vanguard Value ETF has AUM of $102 billion and charges 4 bps in annual fees. The product trades in a volume of 2.8 million shares per day on average and has a Zacks ETF Rank #1 with a Medium risk outlook.
Higher rates have been cruel to bond investors, especially the longer-term ones, as an increase in rates has led to rising yields and lower bond prices. This is because price and yields are inversely related to each other and might lead to huge losses for investors who do not hold bonds until maturity. As a result, short-duration bonds are less vulnerable and a better hedge to rising rates.
JPMorgan Ultra-Short Income ETF invests primarily in a diversified portfolio of short-term, investment grade fixed-and floating-rate corporate and structured debt while actively managing credit and duration exposure. It holds 629 bonds in its basket with an average duration of 0.27 years. JPMorgan Ultra-Short Income ETF has accumulated $22.2 billion in its asset base while trading in a good volume of around 5.2 million shares a day. It charges 18 bps in annual fees.
Floating Rate Bonds
Floating rate bonds are investment grade and do not pay a fixed rate to investors but have variable coupon rates that are often tied to an underlying index (such as LIBOR) plus a variable spread, depending on the credit risk of issuers. Since the coupons of these bonds are adjusted periodically, these are less sensitive to an increase in rates compared to traditional bonds. Unlike fixed coupon bonds, these do not lose value when the rates go up, making the bonds ideal for protecting investors against capital erosion in a rising-rate environment (read: Floating Rate ETFs to Manage Higher Rates).
iShares Floating Rate Bond ETF follows the Bloomberg Barclays US Floating Rate Note < 5 Years Index and holds 387 securities in its basket. The fund has an average maturity of 1.72 years and an effective duration of 0.05 years. iShares Floating Rate Bond ETF has amassed $9.1 billion in its asset base while trading in a volume of 1.6 million shares per day on average. It charges 15 bps in annual fees.e
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SPDR S&P Regional Banking ETF (KRE): ETF Research Reports
Vanguard Value ETF (VTV): ETF Research Reports
SPDR S&P Insurance ETF (KIE): ETF Research Reports
iShares Floating Rate Bond ETF (FLOT): ETF Research Reports
JPMorgan UltraShort Income ETF (JPST): ETF Research Reports
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