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U.S. yields have seen a solid surge on Fed’s tightening policy. The 10-year Treasury yields hit the 3% mark for the first time since late 2018, while 30-year yields hit the highest level to 3.066% since March 2019.
The massive gain came on the back of growing expectations that the Fed will raise interest rates by 50 bps in its latest Fed meeting to fight the 40-year high inflation. Additionally, the central bank will start “to reduce the balance sheet at a rapid pace as soon as May meeting.”
Pros and Cons
A rising rate environment is highly beneficial for cyclical sectors like financial, technology, industrials, and consumer discretionary. In particular, banks are at the most advantageous position as they seek to borrow money at short-term rates and lend at long-term rates. If interest rates rise, banks would be able to earn more on lending and pay less on deposits. This would expand net margins and bolster banks’ profits. Also, insurance companies are able to earn higher returns on their investment portfolio of longer-duration bonds (read: Go Short on Rate-Sensitive Sectors With ETFs as Rate Rises).
Higher rates would attract more capital to the country from foreign investors, thereby boosting the U.S. dollar against the basket of other currencies. However, this would have a huge impact on commodity-linked investments, suggesting that a rising rate environment will 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.
Further, higher rates would also result in tighter lending conditions and curtail consumer spending on a wide range of products like cars and houses. This will, in turn, lower profitability across various segments.
Given this, we have highlighted three ETFs that will benefit from higher yields and the ones, which will be badly impacted.
ETFs to Gain
SPDR S&P Regional Banking ETF KRE
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 139 stocks in its basket, with each accounting for no more than 2% of the assets.
SPDR S&P Regional Banking ETF has AUM of $4.1 billion and charges 35 bps in annual fees. It trades in an average daily volume of 12.7 million shares and has a Zacks ETF Rank #2 (Buy) with a High risk outlook.
Vanguard Consumer Discretionary ETF VCR
Vanguard Consumer Discretionary ETF follows the MSCI U.S. Investable Market Consumer Discretionary 25/50 Index and holds 305 stocks in its basket. In terms of industrial exposure, Internet & direct marketing retail and automobile manufacturers occupy the top spots with double-digit exposure each.
Vanguard Consumer Discretionary ETF is the low choice in the space, charging investors only 10 bps in annual fees while volume is good at nearly 115,000 shares a day. The fund has managed about $6 billion in its asset base so far. Vanguard Consumer Discretionary ETF has a Zacks ETF Rank #2 with a Medium risk outlook.
Invesco DB US Dollar Index Bullish Fund UUP
Invesco DB US Dollar Index Bullish Fund offers exposure against a basket of six world currencies. This is done by tracking the Deutsche Bank Long USD Currency Portfolio Index - Excess Return plus the interest income from the fund’s holdings of U.S. Treasury securities. In terms of holdings, Invesco DB US Dollar Index Bullish Fund allocates nearly 57.6% in euro and 25.5% collectively in the Japanese yen and British pound.
The fund has managed an asset base of $1 billion while seeing an average daily volume of around 1.7 million shares. UUP charges 78 bps in annual fees and has a Zacks ETF Rank #2 (Buy) with a Medium risk outlook (read: ETFs to Tap Dollar Surge Amid Rising Rates).
ETFs to Lose
Utilities Select Sector SPDR XLU
With AUM of $15.6 billion, Utilities Select Sector SPDR seeks to provide exposure to companies from the electric utility, water utility, multi-utility, independent power and renewable electricity producers, and gas utility industries. It follows the Utilities Select Sector Index, holding 29 stocks in its basket. Electric utilities takes the top spot in terms of sectors at 62.7%, closely followed by multi utilities (31.6%).
Utilities Select Sector SPDR charges 10 bps in annual fees and sees a heavy volume of around 19 million shares on average. It has a Zacks ETF Rank #3 (Hold) with a Medium risk outlook.
iShares U.S. Home Construction ETF ITB
iShares U.S. Home Construction ETF provides exposure to U.S. companies that manufacture residential homes by tracking the Dow Jones U.S. Select Home Construction Index. With AUM of $1.4 billion, it holds a basket of 47 stocks with a heavy concentration on the top two firms.
iShares U.S. Home Construction ETF charges 41 bps in annual fees and trades in a heavy volume of around 5 million shares a day on average. iShares U.S. Home Construction ETF has a Zacks ETF Rank #2 with a High risk outlook.
SPDR Gold Trust ETF GLD
SPDR Gold Trust ETF tracks the price of gold bullion measured in U.S. dollars, and kept in London under the custody of HSBC Bank USA. It is an ultra-popular gold ETF with AUM of $66.4 billion and a heavy volume of about 13 million shares a day (read: Gold ETFs Continue to Shine After Best Quarter in 2 Years).
SPDR Gold Trust ETF charges 40 bps in fees per year from investors and has a Zacks ETF Rank #3 (Hold) with a Medium risk outlook.
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SPDR Gold Shares (GLD): ETF Research Reports
Invesco DB US Dollar Index Bullish ETF (UUP): ETF Research Reports
iShares U.S. Home Construction ETF (ITB): ETF Research Reports
Utilities Select Sector SPDR ETF (XLU): ETF Research Reports
SPDR S&P Regional Banking ETF (KRE): ETF Research Reports
Vanguard Consumer Discretionary ETF (VCR): ETF Research Reports
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