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Rate Hike in the Cards? Discard These Sector ETFs

Sanghamitra Saha
Mutual Fund Report for TRMCX

Investors must have been worrying about a probable rate hike for quite some time now. The case for a rate hike in December looks almost certain and the U.S. economy is likely to undergo further policy tightening next year. The labor market has been steady lately and the overall economy is on the mend.

Inflation is still subdued. But the next Fed chair Jerome Powell hinted at possible deregulation in the banking sector. Republicans are leaving no stone unturned to turn tax reform proposals into law. All these should boost economic growth in the days to come. As a result, interest rate hawks are looking all set, and increased rates seem just a matter of time now.

As of Nov 29, 2017, the yield on 10-year benchmark Treasury yield was 2.37%, 5 bps higher than what we saw two days ago. If yields stage a steep ascent, stocks are likely to face challenges on a gradual decline in cheap money inflows. Plus, there are some specific sector ETFs that are likely to underperform in a rising rate environment.

Inside the Likely Underperformers

Against this backdrop, high dividend paying sectors including utilities and real estate are appear to be at risk, given their sensitivity to changes in interest rates. Sectors such as telecom are capital intensive in nature. As the funds generated from internal sources are not always enough for meeting their requirements, these companies often need to depend on the debt market.

As a result, a rising rate environment works inversely for these sectors as companies will have a higher interest obligation. Also, these high-yielding sectors fall out of income-hungry investors’ favor if rates rise. As a result, investors may choose to stay away from the below-mentioned ETFs in the coming days.

Utilities Select Sector SPDR Fund XLU

XLU is one of the most popular funds in the utility space. The fund has AUM of $8.2 billion and is a relatively cheaper bet as it charges a fee of 14 basis points a year. It yields about 3.02% annually and has a Zacks ETF Rank #4 (Sell) with a Medium risk outlook (read: ETFs in Focus After Utilities Q3 Results).

Fidelity MSCI Telecommunication Services ETF FCOM

This ETF provides exposure to the U.S. telecom space at a low expense ratio. It has AUM of $123.3 million and charges 8 basis points as fees per year. The fund yields about 3.21% annually. FCOM has a Zacks ETF Rank #5 (Strong Sell) with a Medium risk outlook (read: ETF Winners & Losers if FCC Repeals Net Neutrality).

Wilshire US REIT ETF WREI

The $19.0-million fund gives exposure to the U.S. REIT sector. The fund charges 32 bps in fees and yields about 2.53% annually. It has a Zacks Rank #4 with a Medium risk outlook.

Consumer Staples Select Sector SPDR Fund XLP

Though consumer confidence is pretty upbeat right now, the sector can lose out in a rising rate environment. The $8.17-billion fund charges 14 bps in fees. The product yields about 2.645 annually (read: Consumer Staples ETFs Head to Head: XLP vs. VDC).

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SPDR-CONS STPL (XLP): ETF Research Reports
 
SPDR-UTIL SELS (XLU): ETF Research Reports
 
FID-TELECOM (FCOM): ETF Research Reports
 
WILSHR-US REIT (WREI): ETF Research Reports
 
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