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 of its planned finish in March lately hinted at an imminent end to the rock bottom interest rates era in the developed world. As a result, the 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 and Wells Fargo, large-cap financial ETF Financial Select Sector SPDR ETF (XLF  - ETF report) added over 1.6% on October 5, 2016.

In this regard, we first choose regional bank ETFs like SPDR S&P Regional Banking ETF (KRE - ETF report) 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.

Go Short with Rate-Sensitive Sectors

Needless to say, sectors that perform well in a low-interest rate environment and offer a 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 (SRS - ETF report) , ProShares Short Real Estate (REK) and ProShares UltraShort Utilities (SDP - ETF report) are such inverse ETFs that could be wining bets in a rising rate environment.

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