Expectations that the Federal Reserve is on course to boost interest rates for the first time next month is having the predictable effect of benefiting financial services exchange traded funds.
Financial entities like banks will benefit from expanding margins as rates climb. A rising rate environment may reflect a strengthening U.S. economy, and a healthier economy would help borrowers have an easier time repaying loans, with banks stuck with fewer non-performing assets. Moreover, rising rates means that banks will generate greater revenue from the spread between what they pay deposit savers and the prime rates they charge credit-worthy clients and other highly-rated debt.
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Investors should also target smaller names through the SPDR S&P Regional Banking ETF (KRE) , the largest regional bank-related ETF, along with the iShares U.S. Regional Banks ETF (IAT) and PowerShares KBW Regional Bank Portfolio (KBWR) . Compared to broader financial services ETFs, such as the Financial Select Sector SPDR (XLF) , regional bank funds are more rate-sensitive.
Trending on ETF Trends
“Notably, last week saw the largest inflow into financial stocks in five months, at $500 million. This blogger noted earlier in the week the hefty gains for the SPDR S&P Bank ETF (KBE) is up 3.2% this week and the SDPR Regional Banking ETF. Banks tend to benefit from higher interest rates. Years of ultralow rates have crimped profits for lenders, which make money on the difference between what they pay depositors and what they charge for loans. With rates so low, that spread is minuscule—even money-losing in some cases, such as money-market funds. Higher interest rates should lead to higher profitability,” reports Chris Dieterich for Barron’s.
Furthermore, within the financial space, insurance companies will also capitalize on rising interest rates. Insurance stocks have typically exhibited a positive correlation with interest rates where higher rates have translated to higher growth. Along with generating greater revenue through new higher yielding debt holdings in a rising rate environment, insurers may also capitalize on a healthier economic environment as consumers purchase big-tick items and buy a home, which may mean more insurance policy coverage.
A broad financial sector ETF may include some insurance exposure – XLF has 16.6% in insurance, but investors can also consider insurance sector-specific ETFs. ETF investors can use the SPDR S&P Insurance ETF (KIE) , iShares US Insurance ETF (IAK) and PowerShares KBW Property & Casualty Insurance Portfolio (KBWP) to capture broad exposure to insurance providers as interest rates rise.
SDPR Regional Banking ETF
Tom Lydon’s clients own shares of XLF.
The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.