Worries over longer-than-expected higher interest rates have been playing foul on the stock market in recent weeks. The series of upbeat economic data as well as the latest warning from the Fed officials revived speculation that the Fed could lift interest rates again.

Against this backdrop, investors should be well prepared to protect themselves from higher rates. While there are a number of ways that could prove extremely beneficial in a rising rate environment, ETFs like Simplify Interest Rate Hedge ETF PFIX, Vanguard Value ETF VTV, iShares MSCI USA Quality Factor ETF QUAL, JPMorgan Ultra-Short Income ETF JPST and iShares Floating Rate Bond ETF FLOT from different corners of the market seem compelling picks.

Inside Higher Rate Bets

A raft of strong economic data kept alive fears of interest rates remaining higher for longer. U.S. retail sales came in better than expected, rising 0.7% in July. Activity in the services sector rose unexpectedly in August, with a strong show in both new orders and employment.

Inflation rose for the first time in July after 12 straight months of decline. The Consumer Price Index rose 3.2% year over year, up from an increase of 3% in June, which was the lowest in more than two years. Although inflation has dropped from a peak of 9.1%, it is still significantly above the Federal Reserve’s 2% target. A recent rise in oil prices driven by the anticipation of additional supply cuts from major oil-producing nations, Saudi Arabia and Russia, renewed fears of inflation and the longer-than-expected higher rates.

The Federal Reserve Chair Jerome Powell, at the Jackson Hole Economic Symposium, expressed confidence in continued economic growth in the United States, citing “robust” consumer spending and early signs of a recovery in the housing market. However, the Fed warned that inflation is still too high and that the central bank is prepared to raise interest rates further and keep borrowing costs high until inflation comes down to the target range of 2%. In the latest move, Boston Fed President Susan Collins warned that more policy tightening could still be on the table.

Any Reason to Worry?

Any increase in interest rates will make borrowing expensive, pushing up the cost of buying a new car or house and increasing the cost of carrying credit cards and debt, thus slowing down economic growth. The U.S. dollar will get a boost against the basket of other currencies, thereby leaving a huge impact on commodity-linked investments. Thus, a rising rate environment will hurt a number of segments.

In particular, high dividend-paying sectors such as utilities and real estate tend to be the worst hit, given their higher sensitivity to rising interest rates. Additionally, securities in capital-intensive sectors like telecom are also impacted by higher rates. However, higher interest rates usually indicate a healthy economy, leading to greater consumer power and increased IT spending. This combination of factors will result in increased industrial activity and a pickup in consumer demand.

Interest Rate Hedge

Interest rate hedge ETFs offer protection amid a rising rate environment. Simplify Interest Rate Hedge ETF is the first ETF providing a simple, direct and transparent interest rate hedge. It seeks to provide a hedge against a sharp increase in long-term interest rates and benefit from market stress when fixed-income volatility increases while providing the potential for income.

Simplify Interest Rate Hedge ETF holds a large position in over-the-counter interest rate options intended to provide a direct and transparent convex exposure to large upward moves in interest rates and interest rate volatility. It invests in long-dated put options on 20-year US Treasury bonds to offer the most liquid and the most cost-efficient way of getting interest rate protection. PFIX has accumulated $209.8 million in its asset base and trades in an average daily volume of 168,000 shares. It charges 50 bps in annual fees.

Value

Value stocks tend to perform better in a higher interest rate environment because they are typically less volatile and have more predictable cash flows. The performance of value stocks is often tied to the broader economy. Improving economic indicators, such as strong job numbers, rising consumer spending and robust manufacturing activity, point to a resilient economy.

Vanguard Value ETF targets the value segment of the broad U.S. stock market and follows the CRSP US Large Cap Value Index. It holds 343 stocks in its basket, with each accounting for less than 3.7% of assets. Vanguard Value ETF has AUM of $101.6 billion and charges 4 bps in annual fees. The product trades in a volume of 2 million shares per day on average and has a Zacks ETF Rank #1 (Strong Buy) with a Medium risk outlook.

Quality

Quality investing refers to an investment strategy that focuses on stocks of companies with strong and consistent financial performance, solid management, sustainable competitive advantages and a proven track record. Such stocks tend to be more resilient during economic downturns and often have lower debt levels relative to their peers or have more manageable debt profiles.

With an AUM of $32.6 billion, iShares MSCI USA Quality Factor ETF provides exposure to large and mid-cap stocks exhibiting positive fundamentals (high return on equity, stable year-over-year earnings growth and low financial leverage) by tracking the MSCI USA Sector Neutral Quality Index. QUAL holds 125 stocks in its basket, with each making up not more than a 6.3% share. It charges 15 bps of annual fees and trades in an average daily volume of 1.4 million shares.

Short-Duration Bond

Higher rates have been cruel to bond investors, especially the longer-term ones, as an increase in rates has led to rising yields and lower bond prices. This is because price and yields are inversely related to each other and might lead to huge losses for investors who do not hold bonds until maturity. As a result, short-duration bonds are less vulnerable and a better hedge to rising rates.

JPMorgan Ultra-Short Income ETF invests primarily in a diversified portfolio of short-term, investment grade fixed-and floating-rate corporate and structured debt while actively managing credit and duration exposure. It holds 635 bonds in its basket with an average duration of 0.63 years. JPMorgan Ultra-Short Income ETF has accumulated $22.7 billion in its asset base while trading in a good volume of around 3.4 million shares a day. It charges 18 bps in annual fees.

Floating Rate Bonds

Floating-rate bonds are investment grade and do not pay a fixed rate to investors. These have variable coupon rates that are often tied to an underlying index (such as LIBOR) plus a variable spread depending on the credit risk of issuers. Since the coupons of these bonds are adjusted periodically, they are less sensitive to an increase in rates compared to traditional bonds. Unlike fixed coupon bonds, these do not lose value when the rates go up, making the bonds ideal for protecting investors against capital erosion in a rising-rate environment.

iShares Floating Rate Bond ETF follows the Bloomberg Barclays US Floating Rate Note < 5 Years Index and holds 343 securities in its basket. The fund has an average maturity of 1.75 years and an effective duration of 0.02 years. iShares Floating Rate Bond ETF has amassed $7.2 billion in its asset base while trading in a volume of 1 million shares per day on average. It charges 15 bps in annual fees.
Vanguard Value ETF (VTV): ETF Research Reports

iShares MSCI USA Quality Factor ETF (QUAL): ETF Research Reports

iShares Floating Rate Bond ETF (FLOT): ETF Research Reports

JPMorgan Ultra-Short Income ETF (JPST): ETF Research Reports

Simplify Interest Rate Hedge ETF (PFIX): ETF Research Reports

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Zacks Investment Research

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