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ETFs to Gain as Fed Raises Rates to a 22-Year High
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The Federal Reserve, as widely expected, raised interest rates by a quarter-percentage point and signaled the possibility of further increases ahead. This marks the 11th rate increase in more than a year, a streak that has made mortgages and other consumer and business loans increasingly expensive.
Against this backdrop, many ETFs from various corners of the market are poised to benefit from a rate hike decision. Some of these, like SPDR S&P Insurance ETF (KIE - Free Report) , Invesco KBW Regional Banking ETF (KBWR - Free Report) , Vanguard Value ETF (VTV - Free Report) , JPMorgan Ultra-Short Income ETF (JPST - Free Report) and iShares Floating Rate Bond ETF (FLOT - Free Report) seem compelling picks.
The rate hike brings the benchmark interest rate, the federal funds rate, to 5.25-5.50%, the highest level since March 2001. The increase in interest rates has made borrowing expensive, pushed up the cost of buying a new car or house, increased the cost of carrying credit card debt and slowed down economic growth.
“Recent indicators suggest that economic activity has been expanding at a moderate pace," the Fed said in its statement. "Job gains have been robust in recent months, and the unemployment rate has remained low. Inflation remains elevatedr" (read: 4 Sector ETFs & Stocks to Bet on June Jobs Data).
Inflation in the United States cooled down for the 12th consecutive month in June, with the Consumer Price Index rising 3% year over year — the lowest rate since early 2021. Although inflation has dropped from the peak of 9.1%, it has a long way to go to meet the Federal Reserve's 2% target.
ETFs That Set to Benefit
Insurance
Insurance stocks are among the prime beneficiaries of a rate hike, as these are able to earn higher returns on their investment portfolio of longer-duration bonds. But at the same time, these firms are prone to incurring losses as the value of longer-duration bonds goes down with rising interest rates. Nevertheless, since insurance companies have long-term investment horizons, they can hold investments until maturity and hence, no actual losses will be realized.
SPDR S&P Insurance ETF follows the S&P Insurance Select Industry Index, holding 48 stocks in its basket, with each firm accounting for no more than 2.5% share. About 46% of the portfolio is allocated to property and casualty insurance, while life & health insurance and insurance brokers round off the next two spots with double-digit exposure. SPDR S&P Insurance ETF has managed $496.1 million in its asset base and trades in a good average daily volume of about 852,000 shares. The product has an expense ratio of 0.35% and has risen 7.4% over the past month. Though KIE currently has a Zacks ETF Rank #4 (Sell), it is poised to gain from the Fed decision.
Banks
A rising interest rate scenario would be highly profitable for banks as they seek to borrow money at short-term rates and lend at long-term rates. With the rise in short-term interest rates, banks would be able to earn more on lending and pay less on deposits. This would expand net margins and bolster banks’ profits. Invesco KBW Regional Banking ETF offers exposure to companies, primarily engaged in U.S. regional banking activities and follows the KBW Nasdaq Regional Banking Index. Holding 51 stocks in its basket, it is a relatively less-popular and less-liquid option in the space, with AUM of $64.7 million and an average daily volume of 15,000 shares (see: Regional Bank ETFs: Value Play or Value Trap?).
Invesco KBW Regional Banking ETF charges 35 bps in fees per year from investors and has surged 17% in a month. It has a Zacks ETF Rank #2 (Buy).
Value
Higher yields indicate optimism in the economy backed by increased consumer confidence, rising wages and higher spending. This combination of factors will result in increased industrial activity and a pickup in consumer demand, thereby lifting value stocks (read: Value ETFs Make the Most of the Dow Jones Surge).
Vanguard Value ETF targets the value segment of the broad U.S. stock market and follows the CRSP US Large Cap Value Index. It holds 343 stocks in its basket, with each accounting for less than 3.7% of assets. Vanguard Value ETF has AUM of $103.6 billion and charges 4 bps in annual fees. The product trades in a volume of 2 million shares per day on average and gained 6% in a month. VTV has a Zacks ETF Rank #1 (Strong Buy).
Short-Duration Bond
Higher rates have been cruel to bond investors, especially the longer-term ones, as an increase in rates has led to rising yields and lower bond prices. This is because price and yields are inversely related to each other and might lead to huge losses for investors who do not hold bonds until maturity. As a result, short-duration bonds are less vulnerable and a better hedge to rising rates.
JPMorgan Ultra-Short Income ETF invests primarily in a diversified portfolio of short-term, investment grade fixed-and floating-rate corporate and structured debt while actively managing credit and duration exposure. It holds 641 bonds in its basket with an average duration of 0.72 years. JPMorgan Ultra-Short Income ETF has accumulated $23.6 billion in its asset base while trading in a good volume of around 4 million shares a day. It charges 18 bps in annual fees and has added 0.4% in a month (read: Time for Short-Term Bond ETFs to Enjoy Solid Current Income?).
Floating Rate Bonds
Floating rate bonds are investment grade and 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 issuers. Since the coupons of these bonds are adjusted periodically, they are less sensitive to an increase in rates compared to traditional bonds. Unlike fixed-coupon bonds, these do not lose value when the rates go up, making the bonds ideal for protecting investors against capital erosion in a rising-rate environment.
iShares Floating Rate Bond ETF follows the Bloomberg Barclays US Floating Rate Note < 5 Years Index and holds 336 securities in its basket. The fund has an average maturity of 1.74 years and an effective duration of 0.02 years. iShares Floating Rate Bond ETF has amassed $7.1 billion in its asset base while trading in a volume of 1.2 million shares per day on average. It charges 15 bps in annual fees and has gained 0.5% in a month.
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ETFs to Gain as Fed Raises Rates to a 22-Year High
The Federal Reserve, as widely expected, raised interest rates by a quarter-percentage point and signaled the possibility of further increases ahead. This marks the 11th rate increase in more than a year, a streak that has made mortgages and other consumer and business loans increasingly expensive.
Against this backdrop, many ETFs from various corners of the market are poised to benefit from a rate hike decision. Some of these, like SPDR S&P Insurance ETF (KIE - Free Report) , Invesco KBW Regional Banking ETF (KBWR - Free Report) , Vanguard Value ETF (VTV - Free Report) , JPMorgan Ultra-Short Income ETF (JPST - Free Report) and iShares Floating Rate Bond ETF (FLOT - Free Report) seem compelling picks.
The rate hike brings the benchmark interest rate, the federal funds rate, to 5.25-5.50%, the highest level since March 2001. The increase in interest rates has made borrowing expensive, pushed up the cost of buying a new car or house, increased the cost of carrying credit card debt and slowed down economic growth.
“Recent indicators suggest that economic activity has been expanding at a moderate pace," the Fed said in its statement. "Job gains have been robust in recent months, and the unemployment rate has remained low. Inflation remains elevatedr" (read: 4 Sector ETFs & Stocks to Bet on June Jobs Data).
Inflation in the United States cooled down for the 12th consecutive month in June, with the Consumer Price Index rising 3% year over year — the lowest rate since early 2021. Although inflation has dropped from the peak of 9.1%, it has a long way to go to meet the Federal Reserve's 2% target.
ETFs That Set to Benefit
Insurance
Insurance stocks are among the prime beneficiaries of a rate hike, as these are able to earn higher returns on their investment portfolio of longer-duration bonds. But at the same time, these firms are prone to incurring losses as the value of longer-duration bonds goes down with rising interest rates. Nevertheless, since insurance companies have long-term investment horizons, they can hold investments until maturity and hence, no actual losses will be realized.
SPDR S&P Insurance ETF follows the S&P Insurance Select Industry Index, holding 48 stocks in its basket, with each firm accounting for no more than 2.5% share. About 46% of the portfolio is allocated to property and casualty insurance, while life & health insurance and insurance brokers round off the next two spots with double-digit exposure. SPDR S&P Insurance ETF has managed $496.1 million in its asset base and trades in a good average daily volume of about 852,000 shares. The product has an expense ratio of 0.35% and has risen 7.4% over the past month. Though KIE currently has a Zacks ETF Rank #4 (Sell), it is poised to gain from the Fed decision.
Banks
A rising interest rate scenario would be highly profitable for banks as they seek to borrow money at short-term rates and lend at long-term rates. With the rise in short-term interest rates, banks would be able to earn more on lending and pay less on deposits. This would expand net margins and bolster banks’ profits. Invesco KBW Regional Banking ETF offers exposure to companies, primarily engaged in U.S. regional banking activities and follows the KBW Nasdaq Regional Banking Index. Holding 51 stocks in its basket, it is a relatively less-popular and less-liquid option in the space, with AUM of $64.7 million and an average daily volume of 15,000 shares (see: Regional Bank ETFs: Value Play or Value Trap?).
Invesco KBW Regional Banking ETF charges 35 bps in fees per year from investors and has surged 17% in a month. It has a Zacks ETF Rank #2 (Buy).
Value
Higher yields indicate optimism in the economy backed by increased consumer confidence, rising wages and higher spending. This combination of factors will result in increased industrial activity and a pickup in consumer demand, thereby lifting value stocks (read: Value ETFs Make the Most of the Dow Jones Surge).
Vanguard Value ETF targets the value segment of the broad U.S. stock market and follows the CRSP US Large Cap Value Index. It holds 343 stocks in its basket, with each accounting for less than 3.7% of assets. Vanguard Value ETF has AUM of $103.6 billion and charges 4 bps in annual fees. The product trades in a volume of 2 million shares per day on average and gained 6% in a month. VTV has a Zacks ETF Rank #1 (Strong Buy).
Short-Duration Bond
Higher rates have been cruel to bond investors, especially the longer-term ones, as an increase in rates has led to rising yields and lower bond prices. This is because price and yields are inversely related to each other and might lead to huge losses for investors who do not hold bonds until maturity. As a result, short-duration bonds are less vulnerable and a better hedge to rising rates.
JPMorgan Ultra-Short Income ETF invests primarily in a diversified portfolio of short-term, investment grade fixed-and floating-rate corporate and structured debt while actively managing credit and duration exposure. It holds 641 bonds in its basket with an average duration of 0.72 years. JPMorgan Ultra-Short Income ETF has accumulated $23.6 billion in its asset base while trading in a good volume of around 4 million shares a day. It charges 18 bps in annual fees and has added 0.4% in a month (read: Time for Short-Term Bond ETFs to Enjoy Solid Current Income?).
Floating Rate Bonds
Floating rate bonds are investment grade and 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 issuers. Since the coupons of these bonds are adjusted periodically, they are less sensitive to an increase in rates compared to traditional bonds. Unlike fixed-coupon bonds, these do not lose value when the rates go up, making the bonds ideal for protecting investors against capital erosion in a rising-rate environment.
iShares Floating Rate Bond ETF follows the Bloomberg Barclays US Floating Rate Note < 5 Years Index and holds 336 securities in its basket. The fund has an average maturity of 1.74 years and an effective duration of 0.02 years. iShares Floating Rate Bond ETF has amassed $7.1 billion in its asset base while trading in a volume of 1.2 million shares per day on average. It charges 15 bps in annual fees and has gained 0.5% in a month.