As is widely known, the Consumer Price Index (CPI) continues to climb higher, putting pressure on the Federal Reserve to raise interest rates.
At this point, rate tightening by the Fed is a foregone conclusion, and it's expected to commence as soon as March. The question isn't if or even when rate hikes start, but how many and by how much the Fed lifts borrowing costs. Some insight on those matters arrived Thursday.
“Federal Reserve Bank of St. Louis President James Bullard said he supports raising interest rates by a full percentage point by the start of July -- including the first half-point hike since 2000 -- in response to the hottest inflation in four decades,” reports Bloomberg.
It remains to be seen by how much the Fed lifts rates in March, but Fed funds futures are, as of Feb. 10, pricing in a 46% chance of increase of 50 basis points.
While investors often associate higher interest rates with lower equity prices, history suggests otherwise, indicating stocks often rise against the backdrop of Fed tightening. Second, there are an array of exchange traded funds with which to play rising rates. Consider the following funds.
1. ProShares Equities for Rising Rates ETF (EQRR)
The ProShares Equities for Rising Rates ETF (EQRR) is an ideal rising rates ETF, and not just because its name implies as much. EQRR tracks the Nasdaq U.S. Large Cap Equities for Rising Rates Index with the goal of providing investors with a basket of stocks that can be durable and outperform when Treasury yields climb.
With the objective of beating rising rates, it's not surprising that EQRR's features a concentrated lineup of just 50 stocks spread across only five of the 11 GICS sectors. EQRR allocates more than three-quarters of its weight to just three sectors - financial services, energy and materials. While the rising rates ETF is concentrated, it's doing its job.
“So far, the strategy has performed as expected," according to ProShares research. "Not only were the index returns positive during January, but the strategy has delivered approximately double the returns of the S&P 500 since rates bottomed in early August of 2020.”
2. VanEck BDC Income ETF (BIZD)
Owing to its status as a high-yield fund (it yields 7.85%), the VanEck BDC Income ETF (BIZD) may not strike investors as the ideal rising rates ETF, but it merits further investigation even in the current environment.
Business development companies (BDCs) – the asset class addressed by BIZD – have tangible rising rates benefits because most of the loans held by BDCs are in floating rate notes. Also known as “floaters”, these bonds are less sensitive to rising rates than fixed rate equivalents.
“BDCs generate income based on the difference between interest income from portfolio investments and interest expense on borrowings/debt," according to VanEck research. "On average, over 85% of loans in BDC portfolios feature a floating rate, and this heavy exposure to floating rate notes translates to less sensitivity to rate increases."
3. Invesco Nasdaq 100 ETF (QQQM)
Investors are often led to believe higher interest rates are punitive for technology stocks, but some market observers believe the group won't be punished as severely as some investors expect. That could open the door to opportunities with the Invesco Nasdaq 100 ETF (QQQM) as a rising rates ETF.
“In our view, higher rates may be more positive for Financials than they are negative for Information Technology stocks,” says David Kastner of Charles Schwab. “However, sector winners and losers likely will depend on the pace at which the Fed raises short-term rates, and the impact those higher rates have on the overall stock market, longer-term interest rates and the yield curve.”
QQQM charges 0.15% per year, making it the cost-effective alternative to the popular Invesco QQQ (QQQ).
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
Todd Shriber
Todd Shriber got his start in financial markets as a reporter with Bloomberg News. Later, he became a trader at a Southern California-based long/short hedge fund where he specialized in trading sector and international ETFs leading up to and during the financial crisis. He would later become the web editor at ETF Trends. Currently, he analyzes, researches and writes on ETFs for a variety of Web-based publications and financial services firms.Shriber has been quoted in the Barron's, CNBC.com and the Wall Street Journal. His work has been published on Web sites such as Benzinga, ETF Daily News, ETF Trends, MarketWatch, Fox Business and Nasdaq.com.
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