Liftoff for the Federal Reserve’s tightening cycle is expected to arrive next month, and the prospect of a rate hike of 50 basis points has some equity investors concerned.
However, history indicates that interest rate increases aren’t always bearish for stocks. Actually, stocks frequently perform well against such backdrops. It’s simply a matter of investors tapping into the right strategies. Enter the ProShares Equities for Rising Rates ETF (EQRR ).
EQRR tracks the Nasdaq U.S. Large Cap Equities for Rising Rates Index with the goal of providing exposure to a basket of stocks that can outperform when Treasury yields rise. It appears that EQRR is doing its job.
“So far, the strategy has performed as expected," according to ProShares research. "Not only were the index returns positive during January, but the strategy has delivered approximately double the returns of the S&P 500 since rates bottomed in early August of 2020.”
As experienced investors know, some sectors are positively correlated to rising interest rates, some are negatively correlated to Fed tightening, and others don’t feel much impact one way or the other. EQRR’s lineup is comprised of groups in the first camp, and the fund is home to stocks from just five of the 11 GICS sectors.
“Certain sectors like financials and cyclical industrials and energy—and by extension certain stocks—tend to perform well when rates rise,” adds ProShares. “But that dynamic is not static. Each rising rate cycle can have different macro drivers that can impact the markets in nuanced ways. Capitalizing on this, the rules-based index selects only five sectors and 50 stocks within those sectors to display the strongest recent correlation to 10-year Treasury yields. Those sectors with stronger correlation receive higher weights.”
To that end, it’s not surprising that EQRR allocates almost 30% of its weight to the financial services sector — the group most positively correlated to rising rates. The ProShares fund also adds a layer of inflation protection with a 25.64% allocation to energy stocks, according to issuer data.
A 20.66% weight to materials stocks presents EQRR investors with a value proposition as well as an avenue for capitalizing on rising commodities prices. None of the fund’s holdings exceed a weight of 3.28%.
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