When it comes to exchange traded funds adhering to methodologies involving beta or volatility, it is the low volatility or minimum beta variety that investors, including the PowerShares S&P 500 Low Volatility Portfolio (NYSEArca: SPLV) and the iShares MSCI USA Minimum Volatility ETF (NYSEArca: USMV).
However, with interest rates set to soon rise, ETFs long on cyclical sector exposure could be poised to thrive. Conventional wisdom dictates that the Federal Reserve usually hikes rates when it feels the U.S. economy is strong enough to withstand higher borrowing costs. So those higher rates, in a way, can be seen as a vote of confidence for cyclical sectors.
In turn, investors might want to consider giving a vote of confidence to the PowerShares S&P 500 High Beta Portolio (NYSEArca: SPHB). SPHB is the high beta equivalent of the wildly popular PowerShares S&P 500 Low Volatility Portfolio. [High Beta ETF’s Time to Shine]
“Cyclical sectors like energy, industrials, information technology and materials have historically shown the strongest correlations to interest rates. This makes sense, given that inflationary pressures and higher interest rates often come on the heels of strong economic growth — the same growth that benefits economically sensitive sectors,” according to a recent research note from PowerShares.
That assessment could prove to be good news for SPHB. The ETF has a 21.2% weight to energy stocks, the best-performing sector during the 2004-2006 Fed tightening cycle. Industrials, perhaps the ultimate cyclical sector, are 18.4% of SPHB’s weight while technology and consumer discretionary combine for just over 30% of the fund’s weight.
“A strong economy is likely to boost capital spending, which should bode well for IT shares. However, one of the challenges facing the energy sector is a near-term glut in crude oil supply,” notes PowerShares.
The technology, industrial and materials companies are among cyclical sectors that typically strengthen in a rising rate environment as investors turn away from safer assets and shift into riskier areas of the market. [The Other Side of Volatility ETFs]
For those looking for a more prosaic approach to sector investing in rising rate environments, SPHB does feature a 14.3% weight to the financial services sector. Predictably, the ETF has no exposure to consumer staples, telecom and utilities stocks.
Financials have a five-year correlation of 0.525 to 10-year Treasury yields, the highest among all sectors, but the average among consumer discretionary, energy and industrials is 0.465, according to PowerShares data.
SPHB is up 1.7% this year.
PowerShares S&P 500 High Beta Portolio
