Entering 2023, expectations were in place that the Federal Reserve wouldn’t be as aggressive with interest rate hikes as it was last year.
It’s possible that scenario will eventually be the order of the day, but a month-and-a-half into the year, there’s already been one rate hike, albeit by a modest 25 basis points and 10-year Treasury yields are higher by 3.8% year-to-date.
Those aren’t exactly awe-inspiring data points nor is the fact that the January reading of the Consumer Price Index (CPI) checked in at 6.4%. Some politicians are likely to boast about the fact that 6.4% is well below the 9.1% peak seen last June and that’s true, but it’s also true that the CPI read just 1.4% in December 2020.
In other words, the Fed’s hand may be forced, particularly if future readings of the CPI surprise to the upside. Translation: Investors might do well to consider some of the following exchange traded funds (ETFs) that offer rising rates protection.
VanEck CLO ETF (CLOI)
The VanEck CLO ETF (CLOI) is new on the ETFs for rising rates scene having debuted last June, but it’s an increasingly relevant idea for investors seeking alternative income. Not only does CLOI make good on that promise as highlighted by its 30-day SEC yield of 6%, it democratizes a corner of the bond market that used to be largely off limits to retail investors.
For investors that aren’t familiar with collateralized loan obligations (CLO), this bond segment can function as an alternative to other income fare, such as bank loans, corporate bonds and junk debt. Think about CLOI this way: It delivers a 6% 30-day SEC yield while nearly 79% of its holdings are rated AAA or AA. That combination is hard to find. Plus, CLOI could be an ideal long-term fixed income holding for a variety of investors.
“Over the long term, CLO tranches have performed well relative to other corporate debt categories, including leveraged loans, high yield bonds, and investment grade bonds, and have significantly outperformed at lower rating tiers,” notes VanEck Director of Product Management William Sokol.
Invesco CEF Income Composite ETF (PCEF)
The Invesco CEF Income Composite ETF (PCEF) follows the S-Network Composite Closed-End Fund Index (CEFX) and is another high income idea that can also function as a rising rates ETF. The $740.7 million PCEF is 13 years old and home to 117 closed-end funds, meaning it’s a fund of funds.
With a 30-day SEC yield of 8.46%, PCEF knocks the ball out of the park when it comes to income. Additionally, owing to some 2022 struggles in the asset class, some closed-end funds are offering value today. It appears investors are buying into that notion as PCEF is higher by 8.17% year-to-date. Methodology could also work in this ETF’s favor even as rates rise.
“For example, CEFX offers exposure to certain CEF strategies which may be less at risk from rising interests,” according to VettaFi analyst Roxanna Islam. “These include unleveraged funds or senior loan funds which pay floating coupons. Among leveraged funds, those with higher earnings coverage ratios may have more cushion to withstand earnings pressure. (The distribution coverage ratio is a ratio of fund’s earnings to its distribution.”
Invesco S&P 500 Pure Value ETF (RPV)
As its name implies, the Invesco S&P 500 Pure Value ETF (RPV) seeks to deliver an approach to value stocks that is more pure than the more basic offerings in this vast ETF category. That trait is worth considering amid rising interest rates because history confirms value stocks are often solid bets when the Fed is tightening.
“There is some evidence that value stocks perform well when interest rates and inflation are high,” notes Morningstar analyst Daniel Sotiroff. “Value stocks outperformed their growth counterparts by almost 10 percentage points per year during the 1970s.”
There are other benefits to purity when it comes to both growth and value investing, including the potential for out-performance over the long haul.
“S&P Pure Style Indices typically outperformed their S&P Style Index counterparts in months when their style was in favor,” points out S&P Dow Jones Indices. “Based on data since 1997, S&P Pure Style Indices posted higher average monthly total returns than S&P Style Indices when their style outperformed.”
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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