As the Federal Reserve cogitates on another interest rate hike this month and many adapt their portfolios to the shifting environment ahead, investors should look to targeted sector exchange traded fund plays that do well in a rate-hike cycle.
While income-related equities have traditionally demonstrated the most vulnerability in the year with rates on the rise, the energy, technology and health care sectors have historically outperformed on average relative to the markets, according to Fidelity Investments.
“During the past half-century, energy, technology, and health care have been the best-performing sectors, on average, relative to the market when rates are on the rise, while consumer discretionary and utilities have done the worst,” according to a Fidelity research note.
ETF investors can also access these sectors through targeted plays. For instance, the Fidelity MSCI Energy Index ETF (NYSEArca: FENY), he Energy Select Sector SPDR (NYSEArca: XLE) and Vanguard Energy ETF (NYSEArca: VDE) are popular ways to access the segment.
For technology sector exposure, look to the Fidelity MSCI Information Technology Index ETF (NYSEArca: FTEC), Technology Select Sector SPDR (NYSEArca: XLK) and Vanguard Information Technology ETF (NYSEArca: VGT).
Lastly, the Fidelity MSCI Health Care Index ETF (NYSEArca: FHLC), Health Care Select Sector SPDR (NYSEArca: XLV) and Vanguard Health Care ETF (NYSEArca: VHT) provide access to the broad health care segment.
While the various sector-specific ETFs provide broad exposure to their targeted segments, investors should keep in mind that there are differences in the different ETF offerings. For instance, the Select Sector SPDR line of ETFs have more focused or less diversified exposure since they take holdings from the smaller universe of S&P 500 companies. The Vanguard line may have the most diversity with higher number of components.The Fidelity ETFs, though, are the cheapest of the bunch, which may be more appealing to long-term investors.
Fidelity also warned that sector performances may also vary, depending on the economic environment. In an expanding economy, cyclical sectors outperform, notably the tech segment. On the other hand, in a slowing environment, defensive plays shined, led by health care.
Fidelity strategists also argue that the financial sector may be a good area to look at this time around, given the potential for growth in a rising rate environment, along with potential tax and regulatory changes under the Donald Trump administration.
“Though its historical performance has been mixed when rates rise, our experts think that the financials sector could do well in this rate cycle. Credit has an overwhelming effect on the critical factor of relative earnings growth. In a profit recovery as strong as this one could be—given potential tax and regulatory changes—there is strong potential for improved credit, which could boost financials relative performance,” according to Fidelity.
To access the financial sector, investors can look to the Fidelity MSCI Financials Index ETF (NYSEArca: FNCL), Financial Select Sector SPDR (NYSEArca: XLF), iShares U.S. Financials ETF (NYSEArca: IYF) or Vanguard Financials ETF (NYSEArca: VFH).