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How to Go Short on Rate-Sensitive Sectors With These ETFs

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Soaring yields have taken a toll on rate-sensitive high-yield sectors such as utilities and real estate lately, given their sensitivity to rising interest rates. When interest rates rise, these sectors, which are generally known for the income they generate, fall out of favor as investors could gain similar level of income without taking the stock risk.

In fact, yields surged to the levels not seen in many years. The 10-year yield jumped more than 20 bps over the past week to 3.23%, its highest level since 2011. The 30-year yield rose above 3.43%, its highest level since 2014. The spike came on the back of a spate of upbeat data and hawkish comments from Federal Reserve policymakers (read: Yields Are Soaring: Here's How to Short Treasury With ETFs).

Unemployment in September fell to 3.7% for the first time in nearly 50 years. The U.S. services sector expanded at its fastest pace on record in September per the data from Institute for Supply Management. The ISM non-manufacturing index also rose to the highest level since the index was created in 2008. The combination of these factors triggered inflation fears and speculation for faster-than-expected rate hikes, pushing bond yields higher. Additionally, the escalating worries over the United States and China’s trade clash could drive inflation higher.

Meanwhile, Jerome Powell said the central bank is "a long way" from getting rates to neutral, a fresh sign of more hikes. He further added that the ultra-accommodative policy to bring the economy out of the Great Recession is no longer needed. The central bank, which started tightening monetary policy in 2015, has raised rates thrice this year and is expected to do so again in December.

In such a scenario, 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 rising.

How to Play?

While futures or short-stock approaches are some of the possibilities, inverse ETFs might be good options. Inverse ETFs provide opposite exposure that is a multiple (-1, -2 or -3 times) 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.

However, these funds are cheaper than direct shorting or utilization of futures contracts. Given this, investors seeking to capitalize on 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 (read: Short These Sectors With ETFs as Fed Hikes Again):  

ProShares Short Real Estate ETF REK

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 real estate stocks decline and is suitable for hedging purposes against the fall of these stocks. The product has amassed $8.8 million in its asset base while volume is light at around 6,000 shares a day. REK was up 3.7% in a month.

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 $23.4 million and trades in moderate volume of nearly 29,000 shares. The ETF has gained 6.5% in a month (read: 7 Leveraged/Inverse ETFs Off to a Strong Start in October).

Direxion Daily MSCI Real Estate Bear 3X Shares DRV

This product seeks to deliver three times the inverse performance of MSCI US REIT Index. It has AUM of $18.4 million and average daily volume of around 63,000 shares. The ETF surged 9.7% in a month.

ProShares UltraShort Utilities ETF SDP

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 $4.2 million in AUM and average trading volume of nearly 3,000 shares per day. The product has lost 2.6% in a month.

Bottom Line

Investors should note that these products are suitable only for short-term traders as these are rebalanced on a daily basis (read: all Inverse Equity ETFs here).

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 the friend” in this corner of the investing world.

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