Best Way To Play Rising Rates With ETFs [Select Sector Financial Slct Str SPDR Fd, iShares Dow Jones US Insurance Index ETF, SPDR KBW Regional Banking (ETF)]

ratesWith the Federal Reserve signaling interest rate hike sooner and faster than expected, investors have started looking for some profitable avenues in the rising interest rate environment.  

Fed’s Latest Comments

In the latest FOMC meeting, the Fed stated that it would continue tapering and made another $10 billion reduction in the bond-buying stimulus to $55 billion. The Fed chairperson –Janet Yellen – also said that the timing of increase in interest rates would no longer depend on the unemployment rate threshold of 6.5%, but instead be a combination of employment and inflation indicators.

Interest rate could remain low for “a considerable time”, about six months after shuttering the monthly bond purchases, which most analysts expect by the year-end. As such, short-term interest rates are expected to move up by the middle of 2015.

This change in the timing of possible interest rate hike roiled the global stock and bond markets, resulting in higher yields. However, the financials sector, especially banks and insurance, are seeing strong inflows and is the main beneficiary of a rising interest rates environment (see: all the Financial ETFs here).

ETFs to Consider

Investors could definitely tap this space by investing in the following ETFs and could avoid the single stock risk as well.

Bank ETFs

A rising interest rate scenario would be highly profitable for the banking sector. This is because banks seek to borrow money and pays out short-term rates, and lends back the capital at long-term rates. Though the current ultra-low rates have reduced borrowing costs for banks, it has also has taken a toll on the lending rates, which the bank receives, thereby affecting their net margins.

When interest rates rise, banks would be able to earn more on lending and pay less on deposits. This would expand net margins and boost banks’ profits. Further, U.S. banks now have much stronger balance sheets and their earnings picture continues to improve with economic revival.

Given improving fundamentals, the best way to ride out the surge in this corner of the broad financial market is with SPDR S&P Regional Banking ETF (NYSEARCA:KRE). This is one of largest and the most popular ETFs in the banking space with AUM of nearly $2.6 billion and average daily volume of more than 3 million shares.

The product follows the S&P Regional Banks Select Industry Index, charging investors 35 basis points a year in fees. Holding 81 securities in its basket, the fund is widely spread out across each security, which minimizes the company specific risk thanks to an equal-weigh approach.  However, small cap dominates the fund’s return at 65%, followed by mid caps (24%) and large caps (11%).

The fund added about 4% in the past five trading sessions and currently has a Zacks ETF Rank of 2 or ‘Buy’ with ‘High’ risk outlook.

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