ETF Strategies For A Rising Rate Environment

The dual prospects of a Fed rate hike this year and the European Central Bank’s (ECB) tapering talks ahead ofits planned finish in Marchlately hinted at an imminent end to the rock bottom interest rates era in the developed world. As a result, yield on the 10-year U.S. Treasury note increased 16 bps to 1.72% in the last four days (as of October 5, 2016).

Several U.S. economic readings – in the fields of services and manufacturing sectors, consumer confidence, and Q2 GDP data – came in better lately. Plus, several FOMC members recently advocated policy tightening, citing economic well-being. This resulted in a 60% chance of a December hike at the current level.

Given this, investors must be interested in finding out all possible strategies to weather a sudden jump in the benchmark interest rates. For them, below we highlighted a few investing tricks that could gift investors with gains in a rising rate environment (read: Higher Interest Rates Are Coming, How Do Investors Prepare?):

Tap Regional Banks

Financial stocks are the direct beneficiaries of a rise in long-term bond yields. This time too, there is no exception. Investors should note that despite the prevailing concerns about the financial health of the big banks including Deutsche Bank (DE:DBKGn) and Wells Fargo (NYSE:WFC), large-cap financial ETF Financial Select Sector SPDR ETF (NYSE:XLF) (XLF) added over 1.6% on October 5, 2016.

In this regard, we first choose regional bank ETFs like SPDR S&P Regional Banking ETF (CO:KRE) as these have a tilt toward smaller-cap stocks and are mainly focused on the U.S. economy. Since banks borrow money at short-term rates and lend the capital at long-term rates, the latest spike in long-term bond yields bode well for these ETFs (read: Financial ETFs in Focus on Rising Rates Buzz).

Go Short with Rate-Sensitive Sectors

Needless to say, sectors that perform well in a low interest rate environment and offer higher yield, may falter when rates rise. Since real estate and utilities are such sectors, it is better to go for inverse REIT or utility ETFs. ProShares UltraShort Real Estate (AX:SRS) , ProShares Short Real Estate (REK) and ProShares UltraShort Utilities (LON:SDP) are such inverse ETFs that could be wining bets in a rising rate environment (read: Rate Hike Bet Put These Inverse Sector ETFs in Focus).

Play Private Equity ETFs

As bond yields have started to rise, investors now need to focus on stable bets that offer way higher than the benchmark yield. For this, the private equity ETF pack is an option. As per the source, private equity topped the Russell 3000 and S&P 500 equity gauges in the recent past (one year) by 3.6% and 1.5%, respectively, as well as in the long term (last 10 years) by 3.8% and 3.7%, respectively.

Investors should note that this asset class is high dividend in nature. PowerShares Global Listed Private Equity ETF (V:PSP) yields about 3.66% annually. Private equity has a low correlation to the broader market but might underperform severely in the global meltdown (read: Can M&A ETFs Surge in 2H?).

Still Want Bond Exposure? Look at These ETFs

Floating rate notes are investment grade bonds that 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 the issuers. Since the coupons of these bonds are adjusted periodically, they are less sensitive to an increase in rates compared to traditional bonds (read: Hedge Rising Rates with Floating Rate ETFs).

Unlike fixed coupon bonds, these do not lose value when rates go up, making the notes ideal for protecting investors against capital erosion in a rising rate environment. iShares Floating Rate Bond FLOT is a good bet in this context (read: FLOT vs. FLRN: The Best Floating Rate ETF).

Another option in this space is to tap bank loan ETFs like Highland/iBoxx Senior Loan ETF (SI:SNLN) . Senior loans, also known as leveraged loans, are private debt instruments issued by a bank and syndicated by a group of banks or institutional investors. These provide capital to companies that have below-investment grade credit ratings. In order to compensate for this high risk, senior loans usually pay higher yields.

Plus, shorting U.S. treasuries is also a great option in this type of a volatile environment (read: 4 Inverse Bond ETFs to Watch as Rates Rise).

EM Bonds & Dividends: Good Bond Picks Too?

Since emerging markets (EM) are quite solid at the current level as opposed to the developed world, have relatively lower date-to-GDP ratio and offer higher yields, investors can take a look at EM bond ETFs.

Though local currency bond ETFs like WisdomTree Emerging Markets Local Debt ETF (TO:ELD) have been outperforming lately, investors might think about a currency-hedged EM ETF at this moment given the renewed strength in dollar. iShares JPMorgan (NYSE:JPM) USD Emerg Markets Bond ETF (AX:EMB) can be a decent pick for those who look to be invested in the currency-hedged EM bond ETF pack (read: 5 Reasons to Invest in Emerging Market Bond ETFs).

Another way to play the emerging market turnaround right now is to invest in high-dividend EM equities ETFs like SPDR S&P Emerging Markets Dividend ETF (EDIV) and iShares Emerging Markets Dividend ETF DVYE that yield over 4.5% -- much higher than the present benchmark Treasury yields.

Ex-Rate Sensitive ETFs Deserves a Look

Since both presidential election and rate hike fears will cause considerable volatility in the market, a low volatile and an ex-rate sensitive pick like &P 500 ex-Rate Sensitive Low Volatility Portfolio (XRLV) should be an intriguing choice (read: 4 Best ETFs to Buy for Q4).

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