These enhanced or smart beta bond ETFs can maintain familiar risk profiles, are overweight in credit and underweights in Treasuries, and potentially generate higher income within defined risk constraints. When comparing the underlying Bloomberg Barclays U.S. Aggregate Enhanced Yield Index to the benchmark Bloomberg Barclays U.S. Aggregate Index, the Enhanced Yield methodology has a lower tilt toward U.S. Treasuries, which may experience greater rate risk ahead, and ups its exposure to credit to improve yield generation.
Joseph Tenaglia, Asset Allocation Strategist at WisdomTree, also warned that stock investors shouldn’t forget about the risks of rising interest rates on their equity portfolios.
“Rising yields have had a positive relationship with stocks when yields are low, but rising yields at higher levels have typically been a detriment to stocks,” Tenaglia said.
Specifically, Tenaglia pointed out that when interest rates rose less than 0.5%, the size and value factors outperformed. When interest rates rose 0.5% to 1.0%, the momentum factor outperformed. Lastly, when interest rates rose more than 1%, the size factor outperformed while the low-volatility factor exhibited a big underperformance.
Tengalia partially attributed the outperformance of the size factor or to small-cap companies due to the fact that more than half of the Russell 2000’s debt is floating rate, compared to less than 30% in the S&P 500. Additionally, rising interest rates could pressure companies with insufficient earnings to cover increasing interest obligations
Consequently, stock investors who are concerned about rising interest rates should lean towards quality, mid- and small-caps with a focus on fundamentals through the WisdomTree MidCap Earnings Fund (NYSEArca: EZM) and WisdomTree SmallCap Earnings Fund (NYSEArca: EES). People can also seek low correlation over low volatility with the WisdomTree U.S. Multifactor Fund (Cboe: USMF). Lastly, investors can also look to “DivProxiesidend Growers” over bonds through something like the WisdomTree U.S. Quality Dividend Growth Fund (NASDAQ: DGRW).
Financial advisors who are interested in learning more about strategies for a rising rate environment can watch the webcast here on demand.