As the U.S economy begins to “normalize” (barring any unforeseen fallouts from trade disputes and tariff wars!), the Fed will gradually increase interest rates. This will mean that Treasury yields could rise – perhaps even significantly. So, what does that mean for your portfolio?
Well, if Treasury yields continue to drift higher, it will likely have a drag-down effect on the fixed-income portion of your portfolio. The value of your current bond/fixed-income holdings will decline, because they likely have a lower yield than newer, higher-yielding instruments. Additionally, if your portfolio is heavily tilted towards the large U.S money-centric banks, rising interest rates could erode some of the recent gains that your portfolios have experienced.
So, where do investors turn to in a rising interest rate environment? We have two ideas that comprise of ETFs that invest in U.S Regional Banks and Negative-duration Bonds.
Given the backdrop of rising interest rates in the U.S., and in fact in several developed economies, how should investors position their portfolios to benefit from such hikes? Well, here are two investment ideas for you to consider:
1) SPDR S&P Regional Banking ETF (NYSEARCA: KRE)
As interest rates and banks go, generally speaking, the larger national money-centric banks tend to gain less from rising rates, than do their smaller regional-focused peers. That’s because regionals have more torque in a rising interest rate with better margin improvements. And KRE is one ETF that’s ideally positioned to benefit from impending rate hikes.
This ETF seeks to closely track the performance of the S&P Regional Banks Select Industry Index (SPSIRBK), which is a sub-index of the S&P Total Market Index (“S&P TMI). 80% of its capital is invested in securities of regional U.S. banks. Over a 1-year period, KRE has returned +11.5% to its holders. However, individual components within the ETF have fared much better:
- BB&T Corporation (NYSE: BBT) +18.48% over a 1year period
- SVB Financial Group (NASDAQ: SIVB) +74.82%
- Texas Capital Bancshares, Inc. (NASDAQ: TCBI) +28.49%
- PacWest Bancorp (NASDAQ: PACW) +52.20%
By comparison, at the time of this writing, the SPSIRBK has delivered a 1-year return of 19.27%.
A word of caution to investors intending to add KRE to their portfolios: Remember, this is a non-diversified ETF that predominantly holds U.S. regional banks.
2) WisdomTree Negative Duration High Yield Bond Fund (NASDAQ: HYND)
Before we talk about HYND, lets understand what it is.
This ETF seeks to generate returns for its investors by employing a long-short strategy of bond investments, both in terms of U.S Treasuries and corporate bonds. And how specifically does that work? The negative duration bond investment strategy provides investors exposure to the traditional (“long”) bond market, but at the same time they “short” Treasury bonds by using complex strategies such as futures, options and interest-rate swaps, that diminish the “long” duration of their holdings. The net is that the ETF holds negative duration investments.
This strategy cushions investors from the negative effects of rising interest rates by getting inversely exposed to U.S. Treasuries, thereby rising in value as interest rates rise.
Some of the holdings in the fund include bonds from companies like:
- Sprint Communications
- Valent Pharmaceuticals
- MGM Resorts
- Dell Int. LLC
- Royal Bk Scotland
- American Airlines Group
- Sirius XM Radio Inc
- Yum! Brands Inc
All of these investments result in a well-diversified basket of corporate and government fixed-income investments. At the time of this writing, HYND has delivered a return of 1.5% to its investors, but on a longer-term (2-year) view, it has returned an impressive 12%.
Before you invest in these two products, you should understand that they will only benefit your portfolios in a rising interest rate environment which, from all indications, is what the U.S. is facing. Increasing corporate profits, rising employment rate and the lowering of tax rates have sparked a revival in the U.S. economy, which signals interest rate hikes are on the horizon.
However, if that thesis doesn’t hold true – for whatever reason, then you may need to revisit your decision to invest in these two products.
Author does not have investment in stock discussed in this article. Sign-up for our newsletter so you don’t miss any hot investment opportunities. Also download our recently published Best Blockchain Stock To Invest In Right Now or Volatility Survival Guide report absolutely free.