One of the biggest questions that the market has been facing
in the past few months relates to the Fed's scaling down of its
bond purchase program. Conflicting statements from the Fed
officials have only added to the uncertainty. However despite
uncertainty related to the actual timing of the start of
tapering-whether it would be September, December or even sometime
next year-investors have certainly started preparing for the
In anticipation of the imminent tapering, interest rates have
been inching up. Though the 10 year yield has come down from a
high a 2.75% reached in early July, it is still very high
compared with a low of 1.61% reached in early May this year.
3 Sector ETFs to profit from Rising Rates
Investors worried about the imminent rise in rates have been
dumping long-duration bonds and bond funds. But the fund flows
shows that while investors are cashing out of longer term bonds,
they are not yet ready to put that money into stocks; they have
instead put that money as cash or into short-term and floating
rate bond funds.
While long-term bond
including investment grade (LQD) and high yield (JNK) were among
the top ten asset losers, short-term bond ETFs like SHV and BSV
and senior loan ETFs BKLN have been among the top gainers this
3 Sector ETFs to avoid as rates rise
Some investors have bet on rise in interest rates by using
inverse bond ETFs and have also profited from such strategies.
Such investors need to keep in mind that leveraged and inverse
ETFs are not meant for long term holding as they are designed to
achieve their objectives on a daily basis and also because of
their usually higher expenses.
Below we have analyzed three ETFs that investors could
consider in the rising rates environment. (Read:
Best ETFs from the market's top sector
PowerShares Senior Loan Portfolio (
Senior loans are secured by company's assets and are thus
lower in risk structure, even though these loans are mostly
issued by companies with below investment grade credit. These are
floating rate loans so they usually pay a spread over some
benchmark rate like LIBOR. Thus, in the event of rise in
interest rates, coupons on senior loans increase while the value
of the investment remains stable. On the other hand, bonds lose
value if the interest rates go up.
So, investors in senior loans or in senior loans ETFs get the
benefit of high yields with protection against any interest rate
rise. Further, they carry lower credit risk compared with most
other assets with similar level of yield. Additionally
senior loans have low correlations with other asset classes.
BKLN is based on the S&P/LSTA U.S. Leveraged Loan 100
Index which is designed to track the largest institutional
leveraged loans based on market weightings, spreads, and interest
The ETF currently holds about 131 securities in total. With
most of these holdings maturing between one and ten years, the
fund has years to maturity at 5.18. In terms of credit rating,
about 42% of the holdings are "BB" while 44% are ranked "B" by
The product is slightly expensive with an expense ratio of 66
basis points a year, but it pays out an attractive dividend yield
of 4.62% at present.
The ETF was launched in March 2011 and has managed to attract
about $5.1 billion in assets so far. The volume is generally very
high, giving the fund an extremely low bid ask spread.
iShares Floating Rate Note Fund
Launched in June 2011, FLOT tracks the Barclays US Floating
Rate Note less than 5 Years Index. The index comprises US dollar
denominated investment grade floating rate notes with a remaining
maturity of greater than one month and less than five years.
The variable coupon for the notes in the index is equal to an
aggregate of 1/3/6 months LIBOR rate plus a fixed coupon spread
depending on the credit risk of the issuers.
The fund currently holds 290 notes with a weighted average
maturity of 1.8 years. The ETF charges a low 20 bps in annual
fees from investors. The product has seen an impressive asset
inflow this year, pushing its asset base to $2.6 billion. With
just 13.6% of the asset base in top ten holdings the fund is very
well diversified, limiting the default risk of any individual
iShares Short Treasury Bond ETF (
The product that made its debut in January 2007 now has a
massive $4.6 billion in AUM. It holds 17 securities as of
The fund has a weighted average coupon of 1.45% and an
effective duration of just 0.45. It charges only 15 basis points
in expenses, lower than the category average of 23 basis
This product is suitable only for investors looking for
'ultra-safe' investment, which can add some diversification
benefits to their equity portfolio. It can also be a substitute
for money market funds. Investors looking to 'park' their cash
for some time before they decide where to invest could consider
Further, investors may prefer short duration ETFs to money
market funds, in view of some of the SEC's proposed reforms.
Want the latest recommendations from Zacks Investment
Research? Today, you can download
7 Best Stocks for the Next 30 Days
Click to get this free report >>
PWRSH-SNR LN PR (BKLN): ETF Research Reports
ISHARS-FL RT BD (FLOT): ETF Research Reports
ISHARS-SH TB (SHV): ETF Research Reports
To read this article on Zacks.com click here.
Want the latest recommendations from Zacks
Investment Research? Today, you can download 7 Best Stocks for
the Next 30 Days. Click to get this free report