ETFs For Higher Rates And Inflation

Mortgage REITs

Real estate investment trusts (REITs) that hold paper, rather than property, can capitalize upon a steepening yield curve, a common artifact of inflation. Mortgage REITs, in most instances, are an arbitrage because issuers borrow money at the short end and lend or invest at the long end. They can make money in a rising-rate environment provided long-term rates rise faster than short-term rates.

The VanEck Vectors Mortgage REIT Income ETF (NYSE Arca: MORT) tracks a market-cap-weighted index of 26 mortgage REITs, though it’s heavily concentrated. Nearly 14 percent of its portfolio space is taken up by its top name.

While the 35-issue iShares Mortgage REIT Capped ETF (NYSE Arca: REM) portfolio is a bit broader than MORT, it’s no less concentrated. REM’s topmost component, in fact, accounts for more than 17 percent of the fund’s assets.

Leveraged Loans

Leveraged loans are floating rate notes also known as bank or senior loans. The reason for the various names is simple. Each moniker denotes a feature of the marketplace. These loans are leveraged because they’re obligations of companies that typically already have a high amount of debt and are often characterized by lower credit ratings or higher interest rates. They’re bank loans because they’re syndicated by merchant banks. And they’re senior loans because they have repayment priority over subordinated debt and preferred shares. These notes are commonly secured by company collateral.

Leveraged loan yields float along with the London Interbank Offered Rate (Libor), and reset periodically. A loan, for example, may use three-month Libor as its reference rate, specify a spread, such as 250 basis points above the reference, and further call for quarterly resets.  

As commercial loan rates rise, so too should leveraged loans yields—until they don’t. These loans, after all, are made to companies that may be overburdened by debt service. While insulated from some interest rate risk, they still convey substantial credit risk.

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DisclosureBrad Zigler pens's Alternative Insights newsletter. Formerly, he headed up marketing and research for the Pacific Exchange's (now NYSE Arca) ...

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