The global economy has been on a solid footing with a rise in commodity prices, recovery in investment, boom in manufacturing and strong trade. The World Bank expects global economy to expand 3.1% this year while International Monetary Fund (IMF) projects global growth of 3.9% — the fastest expansion since 2011. The IMF attributes half of the growth to the new tax legislation in the United States.
Amid surging global economic growth, investors are betting on an inflation comeback and the prospect of faster-than-expected monetary policy tightening. The cheap monetary policy era ended in Asia with South Korea becoming the first major central bank to increase interest rates for the first time in more than six years. The Bank of England, too, has raised interest rates for the first time in more than 10 years (read: ETFs in Focus as South Korea Raises Rates).
The European Central Bank (ECB) will start cutting its massive €60 billion per month asset buying program to halve from January 2018 until at least September 2018 while the Bank of Japan will continue its massive stimulus program until the economy reaches a sustained 2% inflation.
As such, U.S. Treasury yields increased sharply with the 10-year yields now at 2.72% at the time of writing, up from 2.46% at the start of the year. The two-year yields climbed to 2.03% from 1.92%. The latest job data, which showed that wages grew at the fastest pace since 2009, has bolstered the ascent in bond yields lately. This is especially true as robust numbers sparked fears of inflation and the resultant increase in interest rates. Higher inflation could force the Fed to hike rates aggressively this year (read: Sector ETFs Set to Soar Post Strong January Job Data).
As rates rise, bond investors might experience heavy losses given that bond prices and yields have an inverse relationship. While this is true, there are still several compelling choices in the fixed income ETF world that could protect investors from rising rates. Below we highlight five ETFs that could be great picks in a rising rate environment.
iShares Floating Rate Bond ETF (FLOT - Free Report)
This ETF offers exposure to U.S. floating rate bonds, whose interest payments adjust to reflect changes in interest rates. Since the coupons of these bonds are adjusted periodically, they 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.
FLOT follows the Bloomberg Barclays US Floating Rate Note < 5 Years Index and holds 605 securities in its basket. The fund has an average maturity of 1.98 years and effective duration of 0.16 years. In terms of credit quality, the ETF can be considered a relatively safe option for investors as the fund focuses on better quality notes with 82% of them rated A or higher. The product has amassed $6.8 billion in its asset base while trades in volume of 1.1 million shares per day on average. It charges 20 bps in annual fees (read: Floating Rate ETF Hits New 52-Week High).
PowerShares Senior Loan Portfolio (BKLN - Free Report)
This ETF tracks the S&P/LSTA U.S. Leveraged Loan 100 Index providing fixed-income investors with attractive yield potential, while mitigating the risks of a rising interest rate. Unlike fixed-rate instruments, the coupons of floating rate bank loans adjust upward as interest rates rise, providing investors with the potential of an attractive source of current income while at the same time offers compelling yield potential, with their floating rate coupons and low durations.
This is the most popular and liquid fund in the senior loan space with AUM of $7.9 billion and average daily volume of about 3.4 million shares. It holds 111 securities in its basket with average maturity of 5.28 years and days to reset of 28.56. The product charges 65 bps in fees a year and has an attractive dividend yield of 3.46%.
iShares Short Treasury Bond ETF (SHV - Free Report)
Higher rates might lead to huge losses for investors who do not hold bonds until maturity. As a result, short-duration bond ETFs like SHV acts as a better hedge to rising rates. The fund is actively managed and seeks to manage interest rate risk while maximizing current income through diversified exposure to short-term bonds. It holds 28 securities in its basket, with average maturity of 0.42 years and effective duration of 0.41 years. The product has amassed $8.7 billion in its asset base while trades in a solid volume of 740,000 shares a day. It charges 15 bps in annual fees (see: all the total Bond Market ETFs here).
WisdomTree Barclays U.S. Aggregate Bond Negative Duration Fund (AGND - Free Report)
This fund helps investors maintain traditional bond exposure while mitigating their overall sensitivity to rising interest rates by tracking the Bloomberg Barclays Rate Hedged U.S. Aggregate Bond Index, Negative Five Duration. It utilizes an Institutional style approach that combines a long position in bonds representative of the Bloomberg Barclays U.S. Aggregate Bond Index with a short position in Treasury securities to target a negative duration. As a result, it could act as a powerful hedge and a money enhancer in a rising rate environment.
The product has accumulated $17.7 million in its asset base while trades in average daily volume of 10,000 shares. It charges 28 bps in annual fees from investors.
WisdomTree Barclays Interest Rate Hedged U.S. Aggregate Bond Fund (AGZD - Free Report)
Like AGND, this fund also combats rising interest rates an utilizes an institutional style approach that combines a long position in bonds representative of the Bloomberg Barclays U.S. Aggregate Bond Index with a short position in Treasury securities to target zero duration. It follows the he Bloomberg Barclays Rate Hedged U.S. Aggregate Bond Index, Zero Duration. The fund has been able to manage $28.9 million in AUM and trades in a light average volume of almost 5,000 shares per day. Expense ratio comes in at 0.23%.
Sit Rising Rate ETF (RISE - Free Report)
This ETF is a strategic interest rate-hedging tool that gives investors the opportunity to benefit from the rise in the interest rates. The portfolio targets a negative 10-year duration using futures and options on two, five and 10-year maturity Treasury futures contracts. The fund has amassed $34.2 million in AUM and trades in light average daily volume of 16,000 shares a day. It charges 43 bps in annual fees and expenses (read: Best Dividend Growth ETFs for Rising Rates).
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