Falling Rates Create Opportunities for ETF Investors

If the recent spike in interest rates is truly reversing, exchange-traded fund investors can take out the old falling-rates playbook and choose from a diverse group of actionable strategies.  

U.S. interest rates broke a years-long slumber in 2022, as the 10-year Treasury bond yield reached 4% for the first time since 2010. Perhaps more noticeable to investors was the fact that the benchmark bond vaulted up to that mark from around 1.5% about a year earlier. The collateral damage from rising inflation and Fed rate increases impacted all types of bonds and bondlike securities. 

Investors can’t control what interest rates do, but they can control how they seek to capitalize on significant moves in rates in either direction. And if inflation continues to moderate, bonds will look more attractive than they have in years.  

For investors seeking to profit from a falling rate scenario, traditional bond strategies are not the only route. Following are a few others to consider. 

The Invesco S&P 500 Equal Weight Utilities ETF (RYU) is dwarfed in size by the Utilities Select Sector SPDR Fund (XLU), whose $16.2 billion asset base makes it the first (and perhaps only) utilities fund many investors think of when researching ETFs in this sector.  

However, RYU, at $391.8 million in assets, has a distinct feature that could work well going forward. Its 33 holdings are equal-weighted. RYU owns the same stocks as XLU, but each stock is weighted around 3%, while 50% of XLU is spread across only seven stocks. 

As Deloitte notes in its 2023 sector outlook: “In 2023, supply chain snags, rising costs, and extreme weather are likely to continue plaguing the power and utilities sector.” But RYU has held up, with a total return of over 5% since the start of 2022, while the S&P 500 declined over the same period.  

Potential Advantage

RYU’s equal-weighted stance may give it an advantage in an era of heightened single-stock risk. Utility yields have not grown much in recent years, leaving RYU’s dividend at only around 2.3%, half its 2015 peak level, so this is a total return situation. 

The iShares 20+ Year Treasury Bond Buy Write Strategy ETF (TLTW) is one of the more unique ETFs to debut last year. It owns the iShares 20+ Year Treasury Bond ETF (TLT) 

 and overlays a covered call writing strategy, rolling that option position each month. Bond market volatility has increased dramatically in an era of higher rates, allowing TLTW to produce a yield of over 12%, more than triple that of the long bond itself.  

Bond volatility will likely remain elevated, as the market has adopted a keen interest in every bit of news related to inflation, recession, Fed activity and credit conditions. TLTW is a multipronged way to capitalize at a time when bond market prices fluctuate more like stock prices than in the past. 

For those with more tolerance for lower quality credit bond exposure, there’s the Van Eck Fallen Angel High Yield Bond ETF (ANGL). This $2.7 billion fund invests in corporate bonds that were issued with investment grade credit ratings (BBB or higher), but have since fallen into “junk” status (BB or below). Thus, the term, “fallen angels.”  

ANGL’s current portfolio yield now stands at around 6.8%. With an effective duration of 5.5 years, this actively managed ETF is likely to draw more attention from investors seeking yield in uncommon investment styles. ANGL was up 4.5% during the first quarter of 2023. 

Interest rates have been directional since 2022, but even more so, they have been volatile. That makes income and total return investing in modern markets a very different proposition, and a much more interesting one for ETF investors than in the past.