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Short These Sector ETFs as Rates Rise

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Rising rate concerns have been playing foul on rate-sensitive sectors since the start of this year. Rates have been extremely volatile with many ups and downs. Yields on the 10-year Treasury bonds are currently hovering around 2.2%, up from 1.89% a month ago but down from 2.37% on May 12.

While the flurry of downbeat economic data and the Fed’s latest FOMC minutes signal no rate hike in June, accelerating job gains and regained momentum in inflation rates might support rate hikes. Last Friday, the Fed indicated that it is on track to raise the interest rates for the first time since 2006 if the world's largest economy continues to show improvements though the path of rate hikes will be gradual (read: 3 ETFs to Watch on Rising Rates).

In such a situation, high dividend paying sectors such as utilities and real estate would be the worst hit given their higher sensitivity to rising interest rates. In fact, rising bond yields have started taking away some sheen from these stocks, putting them under severe pressure for the months to come as well. In spite of avoiding these stocks altogether, investors could make a short-term bearish play on the rate-sensitive sectors as these spaces will continue to trade sluggishly if interest rates keep on rising.

How to Play?

While futures or short-stock approaches are some of the possibilities, inverse ETFs might be a good option. Inverse ETFs provide opposite exposure that is a multiple (-1x, -2x or -3x) of the performance of the underlying sector using various investment strategies, such as, swaps, futures contracts and other derivative instruments.

Since most of these funds seek to attain their goal on a daily basis, their performance could vary significantly from the inverse performance of the underlying index or benchmark, over a longer period when compared to a shorter period (such as, weeks, months or years) due to the compounding effect (read: all Inverse Equity ETFs here).

However, these funds prevent investors from losing more than their initial investment and are also cheaper than direct shorting or utilization of futures contracts. Given this, investors seeking to capitalize the rising rate scenario in a short span could consider any of the following ETFs given the bearish outlook for the sectors. Investors should note that each of the products charge 95 bps in annual fees from investors:  

ProShares UltraShort Utilities ETF ((SDP - Free Report) )

This fund seeks to deliver twice (2x or 200%) the inverse return of the daily performance of the Dow Jones U.S. Utilities Index. It has $8.2 million in AUM and average trading volume of nearly 4,000 shares per day. The product gained 2.7% over the past four weeks (read: Utility/REITs ETFs Plunge on Rate Hike Speculation).

ProShares Short Real Estate ETF ((REK - Free Report) )

This fund seeks to deliver the inverse return of the daily performance of the Dow Jones U.S. Real Estate Index. The ETF makes profits when the real estate stocks decline and is suitable for hedging purposes against the fall of these stocks. The product has amassed $105.1 million in its asset base while volume is moderate at around 55,000 shares a day. REK was up 2.3% over the past four weeks.

ProShares UltraShort Real Estate ETF ((SRS - Free Report) )

The fund offers two times inverse exposure to the performance of the Dow Jones U.S. Real Estate Index. It has managed assets worth $34.5 million and trades in moderate volume of more than 62,000 shares. The ETF added 4.8% in the trailing four weeks.

Direxion Daily Real Estate Bear 3x ETF ((DRV - Free Report) )

This product seeks to deliver three times the inverse performance of MSCI US REIT Index. It has AUM of $11.2 million and average daily volume of around 76,000 shares. The ETF gained about 7.8% in the last four-week period (read: A Comprehensive Guide to REIT ETFs).

Bottom Line

As a caveat, investors should note that these products are suitable only for short-term traders as these are rebalanced on a daily basis.
 
Still, for ETF investors who are bearish on the securities of the high yielding sectors in the near term, any of the above products could make for an interesting choice. Clearly, a near-term short could be intriguing for those with high-risk tolerance, and a belief that the “trend is your friend” in this corner of the investing world.

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