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How to Go Long on Rate Sensitive Sectors With ETFs

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Worries that the coronavirus outbreak will turn into a pandemic led to free fall in the bond yields over the past several weeks. Further, the recent Fed emergency interest rate cut has pushed the yields to record low. Notably, the yields on the 10-year U.S. Treasury note dropped to below 1% for the first time ever and the yields on the 30-year note fell to 1.612%, near its lowest level. Meanwhile, two-year yields tumbled to 0.723% – its lowest since August 2016.

The Fed has slashed the interest rates by half-percentage point to the range of 1.00-1.25% to protect the longest ever economic expansion in the face of the deadly virus. This represents the first emergency rate cut and the biggest one-time cut since 2008.

A Boon

A rate cut is a boon to rate sensitive and high-yield sectors such as utilities and real estate. When interest rates decline, these sectors, which are generally known for the income they generate, gain momentum. Lower rates will push down rates on retail products, such as mortgages and bank loans. This will encourage people to buy more homes and make refinance cheaper. Further, lower interest rates will keep borrowing cost down, thereby resulting in higher consumer spending and rise in economic activities. This will, in turn, increase profitability across various segments.

In such a scenario, investors could make a short-term bullish play on the rate-sensitive sectors as these spaces will continue to trade smoothly in the wake of rate cuts or expectation of further cuts (read: High Yield Dividend ETFs & Stocks to Buy as Fed Cuts Rate).

How to Play?

While futures or long-stock approaches are some of the possibilities, leveraged ETFs might be good options. Leveraged ETFs provide exposure that is a multiple (2 or 3 times) of the performance of the underlying sector using various investment strategies such as swaps, futures contracts and other derivative instruments.

As 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 a year) due to the compounding effect.

However, these funds are cheaper options than direct going long or utilizing futures contracts. Given this, investors seeking to capitalize on the steady/declining rate scenario in a short span could consider any of the following ETFs given the bullish outlook for the sectors.

ETRACS Monthly Pay 2xLeveraged Mortgage REIT ETN Series B

This ETN is linked to the monthly compounded 2x leveraged performance of the MVIS Global Mortgage REITs Index. It charges 40 basis points (bps) in annual fees and has amassed $321.1 million in its asset base. The note trades in average daily volume of 239,000 shares.

ETRACS Monthly Pay 2xLeveraged Mortgage REIT ETN

With AUM of $258.8 million, this ETN is linked to the monthly compounded 2x leveraged performance of the MVIS Global Mortgage REITs Index. It trades in volume of 239,000 shares a day on average and charges 40 bps in fees per year (read: Mortgage Real Estate ETF Hits New 52-Week High).

ProShares Ultra Real Estate (URE - Free Report)

This fund seeks to deliver two times the daily performance of the Dow Jones U.S. Real Estate Index. It has AUM of $132.2 million and average daily volume of about 10,000 shares. URE has expense ratio of 0.95%.

Credit Suisse X-Links Monthly Pay 2x Leveraged Mortgage REIT ETN (REML - Free Report)

This product provides a monthly compounded 2x leveraged long exposure to the price return version of the FTSE NAREIT All Mortgage Capped Index. It has 0.50% in expense ratio and $93.7 million in AUM. The note trades in average daily volume of 69,000 shares.

Direxion Daily MSCI Real Estate Bull 3X Shares (DRN - Free Report)

This product seeks to deliver three times the performance of the MSCI US IMI Real Estate 25/50 Index. It has AUM of $45.4 million and average daily volume of around 44,000 shares. The ETF charges 95 bps in annual fees.

ProShares Ultra Utilities (UPW - Free Report)

This ETF seeks to deliver twice the return of the daily performance of the Dow Jones U.S. Utilities Index. It has $29 million in AUM and average trading volume of nearly 11,000 shares per day. The product has an expense ratio of 0.95% (read: ETFs to Play as Fed Surprises With a Rate Cut).

Direxion Daily Utilities Bull 3X Shares (UTSL - Free Report)

With AUM of $13.4 million, this fund offers three times exposure to the performance of the Utilities Select Sector Index. It charges investors annual fee of 95 bps and trades in moderate volume of 29,000 shares.

Direxion Daily Homebuilders & Supplies Bull 3X Shares (NAIL - Free Report)

It provides leveraged exposure to homebuilders and creates a three-time long position on the Dow Jones U.S. Select Home Construction Index. It charges an annual fee of 95 bps and trades in a lower average daily volume of about 87,000 shares. The fund has accumulated $62.5 million in its asset base (read: 6 Leveraged ETFs That Gained More Than 25% at Halfway Q1).

ETRACS Monthly Reset 2xLeveraged ISE Exclusively Homebuilders ETN

This ETN is linked to the monthly compounded 2x leveraged performance of the ISE Exclusively Homebuilders Total Return Index, charging 85 bps in annual fees. It has accumulated $3.1 million in its asset base and trades in average daily volume of 1,000 shares.

Bottom Line

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

Still, for ETF investors who are bullish 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 long 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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