3 Income ETFs to Watch Ahead of Key Fed Meeting - ETF News And Commentary

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All eyes are currently on the crucial FOMC meeting this week, as the pullback in the easy monetary policy is just around the corner. Investors wait with bated breath to see whether the Fed finally trims its $85 billion in monthly bond purchases this time around.

In a recent Wall Street Journal poll of 46 economists, only one-fourth believes that the taper will begin this week while one-third expect the announcement in January. More than one-third of economists, however, expect the Fed to hold off on the taper until the March 2014 meeting.

The likelihood of Fed tapering has increased in the recent weeks given the slew of upbeat data and economic improvement. The first and foremost driver is the healing labor market. The economy has created 193,000 jobs in the past three months and the unemployment rate has declined gradually. The rate is currently at a five-year low of 7%.

Retail sales rose 0.7% last month buoyed by strong consumer confidence and spending while the manufacturing sector also showed strong signs of acceleration as well (read: 3 ETFs to Profit from the Manufacturing Upswing ).  

Additionally, the congressional Democrats and Republicans are on the verge of a tentative two-year budget deal, which if approved, would end the fiscal instability in Washington. This suggests a much stronger U.S. economic outlook heading into 2014.

Other positive developments in the economy include a solid housing recovery and higher-than expected GDP growth in the third quarter. However, inflation remained near the historical low at 1.1% in November, well below the central bank's 2% target. This might stop the Fed from QE tapering.

Given the large uncertainty in the Fed's stimulus program this week, investors should pay close attention to the income-investing corner of the world that could see heavy trading when the announcement is finally made (read: High Dividend ETFs to Buy Even If the Fed Tapers ).

As yields continue to rise, many investors remain concerned about the income-generating securities in their portfolio. Below, we have highlighted three such sectors that would be in focus and look to be big movers from the upcoming Fed decision:

Mortgage REITs

Thanks to soaring mortgage rates, mortgage REITs have been under immense pressure and could be in more trouble if the Fed starts scaling back its bond purchase program. Both 30-year and 15-year mortgage rates again climbed to 4.42% and 3.43%, respectively.

With the taper announcement, short-term rates would rise faster than the long-term rates thereby leading to a tight spread and lower profits for mREIT companies. Meanwhile, if the Fed refrains from tapering in this meeting, we could see a rebound in this space.

Investors could play this rebound in two ways: iShares FTSE NAREIT Mortgage Plus Capped Index Fund ( REM ) and Market Vector Mortgage REIT Income ETF ( MORT ) . Though both are popular, REM has more AUM and volume while MORT is a cheaper choice. Further, REM has a higher 30-Day SEC yield of 13.39% while MORT yields 11.22%.

From a year-to-date look, REM and MORT lost nearly 6% and 3%, respectively, but could rise if tapering is again stalled (read: Mortgage REIT ETFs in Focus on Renewed Taper Concerns ).

Bonds

Bond mutual funds and ETFs have seen massive outflows this year as their prices persistently slid on taper concerns. According to Trim Tabs Investment Research , total bond funds shed $70.7 billion so far this year through the first week of December, edging past the annual record outflow of $62.5 billion in 1994.

While long-term Treasury bond ETFs have been the worst hit by the taper talk, the sell-off has hit almost all categories. There are a number of bond ETFs to watch in this space, but investors could keep a close eye on the ETF that provides broad exposure to the bond market (read: 3 Bond ETFs Popular in the 'No Taper' Aftermath ).

The PIMCO Total Return ETF ( BOND ) is by far the largest actively managed bond ETF with a total asset base of $3.6 billion and an annual fee of 55 bps. The fund provides significant exposure to mortgage-backed securities (66%) and Treasury bonds (21%).

About three-fifths of BOND's portfolio focuses on mid-term securities ranging from 3-5 years and 5-10 years. Hence, the fund would be in danger if the rates continue to rise. The ETF lost over 1.5% in the year-to-date time frame and pays a decent 1.64% in terms of its 30-Day SEC yield.

Utilities

The utility sector has seen a rough patch over the past few weeks after the return of taper talk. Being defensive, the utility stocks pay outsized yields and when interest rates rise, these become less attractive dulling the appeal of utilities across the board (read: Play Safe with These 3 ETFs ).

However, if Fed holds off on the taper, the sector would be back on track with smooth trading ahead. While there are enough choices in the space, investors should closely watch the ultra-popular Utilities Select Sector SPDR ( XLU ) and the  Vanguard Utilities ETF ( VPU ) .

With AUM of over $4 billion, XLU provides exposure to a small basket of 31 securities with nearly 58% concentration on the top 10 firms. The ETF charges 0.18% in expenses and trades in heavy volume of nearly 11 million shares a day (see: all the Utilities ETFs here ).

On the other hand, VPU has amassed nearly $1.3 billion in assets and charges 14 bps in annual fees. The fund is home to 78 securities and the top 10 companies hold about 46% of total assets. While both the products delivered double-digit returns year-to-date, they have lost over 2.5% since November.

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PIMCO-TOT RETRN (BOND): ETF Research Reports

MKT VEC-MTGE RE (MORT): ETF Research Reports

ISHARS-MTG RE (REM): ETF Research Reports

VIPERS-UTIL (VPU): ETF Research Reports

SPDR-UTIL SELS (XLU): ETF Research Reports

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , ETFs

Referenced Stocks: BOND , MORT , REM , VPU , XLU

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