Multi-asset exchange traded funds have provided diversified exposure to a group of various asset classes and generated attractive yields, but the investments could falter if rates begin to rise this year.
ETF investors have turned to multi-asset strategies for their diversification, tax efficiency attractive yields. For instance, the First Trust NASDAQ Multi-Asset Diversified Income Index Fund (NasdaqGM: MDIV) bas a 6.08% 12-month yield, iShares Morningstar Multi-Asset Income Index ETF (NYSEArca: IYLD) has a 5.32% 12-month yield and Guggenheim Multi-Asset Income Index ETF (NYSEArca: CVY) has a 6.15% 12-month yield.
However, these investment strategies have been shifting away from traditional stocks and bonds split to generate higher yields. Instead, multi-asset ETFs have a broader mix of equities, bonds and cash.
For instance, MDIV includes a 21.8% tilt toward real estate investment trusts, 20.5% dividend paying stocks, 20.4% preferred securities, 20.2% in high-yield corporate debt and 17.1% master limited partnerships. IYLD holds 19.9% junk bonds, 15.3% mortgage REITs, 15.2% investment-grade corporate debt, 14.7% international dividends and 9.6% emerging market local currency debt.
Consequently, the multi-asset ETFs are now exposed to interest rate risks as many of their underlying holdings are sensitive to rate changes.
For instance, higher short-term rates increases funding costs for REITs, and higher long-term rates could raise book values for existing mortgage REITs. If rates rise, the cost of capital for MLPs would also increase, which would lower distributions on the asset and make the play less attractive.
Additionally, preferred stocks become less attractive in a rising rate environment as prices fall to bring yield back up to an attractive level. Most preferred stock have no maturity, which makes them susceptible to duration as well. Preferreds are also at risk in a falling rate environment since issuers could call shares and reissue shares at lower rates.
Bonds would also see prices fall in a rising rate environment, especially those with longer maturities since newer issues would be have higher returns.
For more information on multi-asset investments, visit our multi-asset ETFs category.
Max Chen contributed to this article.