Exchange traded funds tracking large-cap banks and major financial services companies have gotten plenty of attention as credible trades in a rising interest rate environment. Some of those ETFs have delivered as 10-year Treasury yields have jumped since early June, including the Financial Select Sector SPDR (NYSEArca: XLF) and the Vanguard Financials ETF (NYSEArca: VFH).

Likewise, investors have already gotten a glimpse as to what sectors could face headwinds should rates continue to rise. “A rising-rate environment is likely to cause some challenges for yield-oriented equity sectors, notably utilities, as well as parts of the consumer staples, telecom and health care sectors,” said Hernando Cortina, senior equity strategist at Morgan Stanley Wealth Management, in a note. [Rising Yields Smack Rate-Sensitive Sector ETFs]

However, Morgan Stanley extolled a bullish view of the financial services sector as a rising rates trade, although the bank notes the sector is the worst-performing group since October 2007. “We believe that the broad financial sector is likely to be a net beneficiary of higher rates, though the sector’s three main segments—banks & diversified financials, insurance and real estate—will be affected differently,” said Cortina.

Morgan Stanley believes banks are likely to be the biggest beneficiaries of rising rates. Some of that good cheer is already evident as bank-heavy ETFs such as the SPDR S&P Bank ETF (NYSEArca: KBE) and the SPDR S&P Regional Bank ETF (NYSEArca: KRE) are up 6.2% and 8.9%, respectively, in the past month. [An ETF For Earnings Season]

“We expect that banks will benefit most from the higher rate environment, helping to offset some of the pressures on profitability that stem from the higher capital requirements, tighter regulations, credit losses and decreased client activity of the past several years,” according to Cortina.

Morgan Stanley also notes that insurance providers, particularly property and casualty firms, could benefit from a higher rate environment. Years of low interest rates have depressed interest income for insurance firms, but rising rates would reverse that scenario, in turn leading to potentially higher profits for insurance providers. ETFs that could be winners in that situation include the SPDR S&P Insurance ETF (NYSEArca: KIE) and the First Trust Financials AlphaDEX Fund (NYSEArca: FXO). [This Financial Services ETF Has it All]

SPDR S&P Insurance ETF

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