ETFs
Reduce risks with sector ETFs
Fed Expects Inflation Due to High April CPI Number! Investors expect the Fed to start easing its measures in the 2nd half due to a lighter CPI in May!
The heavy dance around positioning for higher or lower rates continues to dog investors as the stock bull market continues. What is certainly true is that the days of “zero interest rate policy” or ZIRP are behind us, and managing the “risk-free” side of a mixed investment portfolio is more difficult than before and may require more tactical measures. tools.
As a sector investor, I would like to highlight the benefits of low stock volume. equity sectors as an excellent portfolio allocation option alongside traditional bond funds. Yields are a bit lower, but volatility profiles are similar and capital gains are generally higher. The chart below highlights the potential for higher capital appreciation in low volume stocks. equity sector funds compared to various popular fixed income funds. The difference in the composition of returns across these asset classes can provide a tactical opportunity for investors and risk managers.
We can see that the large swings in TLT’s performance relative to the generic US 10-year yield are much more volatile than ETFs that focus on the short term and the belly of the yield curve like FBND and BSV. HYG is also interesting and does very well when rates rise, but its vulnerabilities generally increase when security is most needed. We can also clearly see the benefits of rotating into utilities, real estate and basics ETFs when inflation and recession fears materialize, as they did in mid-April.
As the table shows, each of these ETFs has various advantages, but also certain risks. XLRE has been highly volatile over the past two years as the commercial real estate industry has suffered from the pandemic-induced social shift toward remote work. We saw outlier negative returns for TLT, with interest rates revising upwards as the pandemic marked the beginning of the end of the Fed’s ZIRP.
The key point to remember is this. All of these products mentioned will become increasingly important for risk management in a world where interest rates appear to be normalizing to their long-term average levels. As those who have been around the financial markets for a long time remember, 10-year yields of 3-4% were once considered low.
Avoid short-term complacency as rates fall in the short term. Consider a wide range of options, like those mentioned above, for your risk plan. A quick look at a 2-year chart of the 10-year yield and the price dynamics of these different ETFs shows the potential importance of making the right tactical allocations in mixed portfolios. Multi-month rate averaging is likely the name of the game going forward.