Rising 10-year Treasury yields have, predictably, stoked chatter about the vulnerability of interest rate-sensitive asset classes and sectors. Case and point: Utilities stocks and exchange traded funds.
Over the past three months, the Utilities Select Sector SPDR (NYSEArca: XLU), the largest utilities ETF, is off 2.2% as 10-year Treasury yields have surged nearly 13%. There was a time when such a yield spike would have been problematic for the PowerShares S&P 500 Low Volatility Portfolio (NYSEArca: SPLV), particularly if investors did not properly understand how SPLV works, but that is not the case today. [Focused Use of Low Volatility ETFs]
The low-volatility ETF targets 100 of the least volatile stocks from the S&P 500 index and weights the positions inverse to volatility – the least volatile stocks has a greater weight in in the portfolio. That led to spurious accusations that SPLV was a utilities ETF in disguise. Critics will be heartened to learn that the utilities sector is now SPLV’s second-smallest sector weight.
The ETF’s utilities allocation has dwindled to 2.6% as of June 12 from 19.4% in September. In fact, SPLV is underweight utilities stocks by 20 basis points relative to the S&P 500. [Surprises in Low Vol ETFs]
“Given the prospect of higher rates, investors may wish to consider a low volatility investment approach and check their holdings for interest rate sensitivity. Over the past five years, financial stocks have been among the most sensitive to rising interest rates – especially insurance and diversified financial shares,” according to a recent PowerShares note.
Of course, utilities are the group worst affected by rising interest rates. So the double dose of good news for SPLV is its scant utilities weight combined with a 35.6% weight to financial services names, by far the ETF’s largest sector allocation. Digging deeper into SPLV’s financial services lineup reveals opportunity. Seventeen of the ETF’s financial services holdings are either insurance providers or regional banks, two industries that are positively correlated to rising interest rates. [Regional Bank ETFs Surge]
“In fact, since its May 2011 inception, SPLV has exhibited lower volatility than the S&P 500 Index. This is because the fund’s underlying index follows an unconstrained investment approach that allows for dynamic sector rotation,” according to PowerShares. “Due to SPLV’s unconstrained sector rotations, the fund has shed much of its exposure to the underperforming utility sector over the past two years, from just over 30% in March 2013 to under 3% currently.”
SPLV’s primary rival, the iShares MSCI USA Minimum Volatility ETF (NYSEArca: USMV), has a utilities weight of 7.7%, nearly triple that of the PowerShares offering.
PowerShares S&P 500 Low Volatility Portfolio