2 Smart Beta ETFs For Rising Rates

Here are a few next-generation funds to combat higher rates.

Reviewed by: Todd Rosenbluth
Edited by: Todd Rosenbluth

Todd Rosenbluth is director of ETF and mutual fund research at CFRA.

Amid rising rates in 2017, investors have shifted assets away from certain defensive dividend and low-volatility strategies, favoring products that offered more cyclical exposure that can benefit as rates rise.

Yet thanks to continued product innovation, there are now some strong smart-beta strategies that combine some defensive and cyclical components.

Thus far in 2017, the iShares Edge MSCI Minimum Volatility USA ETF (USMV) and the PowerShares S&P 500 Low Volatility Portfolio (SPLV) have shed a combined $1.3 billion in assets. Despite the exposure differences—for example, USMV has sector constraints not employed for SPLV—both offer relatively strong exposure to higher-dividend-yielding stocks relative to the S&P 500 Index.

As the Fed raises rates further this year, a rotation away from these “bond proxies” may occur.

CFRA, an independent research provider covering more than 1,500 stocks and 1,200 ETFs, has “overweight” rankings on both ETFs, based on a combination of holdings-level analysis and fund attributes.

More specifically, SPLV and USMV currently earn favorably low-risk-consideration attributes in our research, which is consistent with the downside protection investors should seek from a lower-volatility product.

Interest Rate Performance Screen

In April 2015, the PowerShares S&P 500 ex-Rate Sensitive Low Volatility Portfolio (XRLV) came to market and has $220 million in assets. Similar to the $6.5 billion SPLV, XRLV focuses on the 100 least volatile stocks in the S&P 500 Index. But XLRV first excludes stocks that historically have performed poorly in rising interest rate environments. Examples of stocks inside SPLV that do not make the cut for XRLV include utilities Dominion Resources and Southern Co.

Rather, those and other utilities are replaced in XRLV by other S&P 500 constituents, including industrials stocks Ametek and J.B. Hunt Transport Services. Both are CFRA buy recommendations that have medium CFRA qualitative risk considerations.

In addition to industrials (25% of assets), information technology stocks (16%) are well represented in XRLV. Apple and Cisco Systems are two such holdings. XRLV also earns low CFRA risk consideration ranking inputs, but a neutral STARS input reflecting our qualitative view of the constituents’ valuation.

What’s Inside Low-Volatility ETFs Can Differ

Sources: iShares, PowerShares, March 17, 2017

In 2017, XRLV was up 5.9% as of March 17, ahead of SPLV’s 5.1%, highlighting the importance of understanding the construction of these index-based products.


Dividend ETF For Rising Rates

Meanwhile, some dividend ETFs, such as the SPDR S&P Dividend (SDY), experienced net outflows year-to-date despite offering exposure to companies with long-term records of dividend increases.

In September 2016, the Fidelity Dividend ETF for Rising Rates (FDRR) launched with a twist on the traditional dividend-growth theme. The proprietary index behind FDRR holds companies that are expected to continue to pay and grow their dividends and have a positive correlation of returns to increasing Treasury yields.

This ETF has a sector-neutral approach, and as such, technology stocks (21% of assets) including AAPL and CSCO, are widely held. Meanwhile, there are utilities (3%) inside, with Exelon Corp as one example.

Kraft Heinz and Walmart (WMT) are among the ETF’s largest consumer staples (9%) holdings and have low CFRA qualitative risk assessments. CFRA equity analyst Joseph Agnese has a buy recommendation on KHC. He thinks the company’s leading market share positions, strong cash flow generation and significant EBITDA margin expansion opportunities positions it well to achieve strong EPS growth over the next three years.

Meanwhile, Agnese believes CFRA strong-buy-recommended WMT is well-positioned to experience accelerated EPS growth over the next three years. He sees WMT growing market share through the implementation of a more aggressive pricing strategy, increases in private label offerings, and improvements in customers’ shopping experience by expanding click-and-collect service.

FDRR Earns Overweight Ranking

Despite also launching less than three years ago, and with only $94 million in assets, CFRA ranks FDRR as overweight. Our ranking is helped by favorable CFRA Stars and overall modest risk consideration attributes.

FDRR was up 6.3% year-to-date, ahead of the 4.5% and 3.5% respective gains for SDY and the Fidelity Core Dividend ETF (FDVV); FDVV focuses on dividend-growth companies but does not incorporate sensitivity to bond yields. 

Source: CFRA, March 17, 2017

With the Federal Reserve raising rates last week and indicating that gradual rate hikes are to be expected throughout the year, CFRA thinks investors should broaden the range of smart-beta products they consider.

While established offerings SDY, SPLV and USMV remain worthy of attention, we contend FDRR and XRLV are next-generation products with some strong attributes.

At the time of writing, neither the author nor his firm held any of the securities mentioned. Todd Rosenbluth is director of ETF and mutual fund research at CFRA, an independent research firm that acquired S&P Global Market Intelligence's equity and fund business in October 2016. He can be reached at [email protected]. Follow him at @ToddCFRA


Todd Rosenbluth is director of ETF and mutual fund research at CFRA, an independent research firm that acquired S&P Global Market Intelligence’s equity and fund business in October 2016. Follow him at @ToddCFRA.