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Consider A Shift To These ETFs As Interest Rates Rise

This article is part of a regular series of thought leadership pieces from some of the more influential ETF strategists in the money management industry. Today’s article features Gary Stringer, president and chief investment officer of Memphis, Tennessee-based Stringer Asser Management.

Operation Twist was the media’s term for the U.S. Federal Reserve’s (Fed) actions in late 2011 and early 2012 when it was trying to “twist” the yield curve by pushing short-term interest rates higher and long-term interest rates lower.

In the 2011 version of Operation Twist, the Fed was trying to stimulate the U.S. economy. We think that next year the Fed will again engage in a yield curve twist, but this time its goal will be to offset some perceived harmful side effects of fiscal stimulus.

As a result of Fed actions, short-term yields may increase 1.0%, while global demand for U.S. Treasury bonds may keep a ceiling on long-term yields at about 0.30-0.50% higher than the current level.

Position Shift Should Be Considered

Based on the theme of stabilizing economic data (see the OECD Composite of Leading Indicators below), investors may want to consider shifts to better position for an environment of increasing near-term inflationary pressure and the resulting implications for interest rates and Fed policy.

Increased expectations for global economic growth and inflation will support higher long-term interest rates, though demand for U.S. Treasury bonds should keep a lid on those rates.

Stronger economic activity can favor corporate bonds over other types of credit.

Investors might consider the iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD) and the PowerShares Fundamental Investment Grade Corporate Bond Portfolio (PFIG) for these allocations.

In response to their perception of building inflationary pressure, the Fed may increase short-term interest rates more persistently and more quickly than consensus expects.

Investors might consider floating-rate ETFs to take advantage of potentially higher short-term interest rates. Examples of the ETFs with this exposure include the PowerShares Senior Loan Portfolio (BKLN), the iShares Floating Rate Bond ETF (FLOT) and the SPDR Blackstone / GSO Senior Loan ETF (SRLN). Since these options invest in floating-rate instruments, they should be able to adjust to higher interest rates without an erosion of principal.

At the time of writing, Stringer Asset Management held PFIG and FLOT among its universe of ETFs included in its suite of ETF Portfolios. SAM is a Memphis, Tennessee third-party investment manager and ETF strategist. Contact SAM at 901-800-2956 or at info@stringeram.com. For a complete list of relevant disclosures, please click here.

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