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Higher Yields to Fuel Rally in These ETFs

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U.S. yields once again have been rising, especially after the renewed aggressive stance by the Federal Reserve. The 10-year Treasury yields hit a two-month high of 3.26%, while 2-year yields jumped to a new 15-year high of 3.51%.

Investors could tap the opportune moment of rising rates through ETFs that will benefit from higher yields. While many ETFs stand to gain, we have highlighted five from different corners of the investing world. These include SPDR S&P Regional Banking ETF (KRE - Free Report) , Vanguard Consumer Discretionary ETF (VCR - Free Report) , Invesco DB US Dollar Index Bullish Fund (UUP - Free Report) , iShares Floating Rate Bond ETF (FLOT - Free Report) and iShares Short Treasury Bond ETF (SHV - Free Report) .

Last week, the Fed said it will likely need to keep interest rates high enough to slow the economy “for some time” to curb high inflation. While tight monetary policy "for some time" will bring down inflation from its 40-year high, it means slower growth, a weaker job market and "some pain" for households and businesses.

Fed funds futures' traders were pricing in a 75% chance of the Fed hiking interest rates by 75 basis points (bps) at its next policy-making meeting on Sep 20-21. They expect interest rates to keep climbing to a high of more than 3.95% in March, with some rate cuts priced in for later next year (read: 75-Bp Rate Hike in September? ETFs to Play).

Why?

A rising rate environment is highly beneficial for cyclical sectors like financial, industrials and consumer discretionary. In particular, banks are in 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.

Higher rates would attract more capital to the country from foreign investors, thereby boosting the U.S. dollar against the basket of other currencies.

Coming to non-equity world, floating rates and short-term bond ETFs are an ideal choice to prepare for higher rates. The floating ETFs offer exposure to U.S. floating rate bonds, interest payments of which adjust to reflect changes in interest rates. Since the coupons of these bonds are adjusted periodically, these are less sensitive to an increase in rates compared with traditional bonds. As such, unlike fixed coupon bonds, these will not lose value when the rates go up. Hence, it protects investors from capital erosion in a rising rate environment.

Meanwhile, short-duration bond ETFs act as a better hedge against rising rates. Higher rates might lead to huge losses for investors who do not hold bonds until maturity.

ETFs to Gain

SPDR S&P Regional Banking ETF (KRE - Free Report)

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 144 stocks in its basket, with each accounting for no more than 2% of the assets (read: Financials ETFs: Can the Rebound Continue?).

SPDR S&P Regional Banking ETF has AUM of $3.3 billion and charges 35 bps in annual fees. It trades in an average daily volume of 5.5 million shares and has a Zacks ETF Rank #1 (Strong Buy) with a High risk outlook.   

Vanguard Consumer Discretionary ETF (VCR - Free Report)

Vanguard Consumer Discretionary ETF follows the MSCI U.S. Investable Market Consumer Discretionary 25/50 Index and holds 312 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 94,000 shares a day. The fund has managed about $5 billion in its asset base so far. Vanguard Consumer Discretionary ETF has a Zacks ETF Rank #1 with a Medium risk outlook.

Invesco DB US Dollar Index Bullish Fund (UUP - Free Report)

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 (read: Dollar at 20-Year High: ETFs to Gain & Lose).

The fund has managed an asset base of $2 billion while seeing an average daily volume of around 3.4 million shares. UUP charges 77 bps in annual fees and has a Zacks ETF Rank #2 (Buy) with a Medium risk outlook.

iShares Floating Rate Bond ETF (FLOT - Free Report)

iShares Floating Rate Bond ETF follows the Bloomberg US Floating Rate Note < 5 Years Index and holds 408 securities in its basket. It has an average maturity of 1.75 years and an effective duration of 0.07 years. iShares Floating Rate Bond ETF focuses on better quality notes, with 83% rated A or higher.

iShares Floating Rate Bond ETF has amassed $9 billion in its asset base while trades in a volume of 1.3 million shares per day on average. It charges 15 bps in annual fees.

iShares Short Treasury Bond ETF (SHV - Free Report)

iShares Short Treasury Bond ETF provides exposure to U.S. Treasury bonds that mature in less than one year and follows the ICE Short US Treasury Securities Index. It holds 51 securities in its basket, with both average maturity of 0.36 years and an effective duration of 0.35 years.

iShares Short Treasury Bond ETF has amassed $19.2 billion in its asset base while trading in a solid volume of 4 million shares a day. It charges 15 bps in annual fees and has a Zacks ETF Rank #4 (Sell) with a Medium risk outlook.
 

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