In light of the Federal Reserve’s decision to cut interest rates, investors can use various ETF strategies to navigate an environment of falling interest rates.
Christopher Huemmer, Senior Investment Strategist at Northern Trust’s FlexShares ETFs, said they believe investors’ search for income will drive flows into three key areas: high yield, dividend products, and real estate.
Lower rates mean that sources of safe / high-quality income like government bonds may no longer be enough. Huemmer said its FlexShares’ High Yield Value-Scored ETF (HYGV) offers investors a renewed focus on yield by maximizing the value factor to enhance total return potential while minimizing risk at the same time.
“In high yield, the value factor is the component of return that does the best job explaining performance and systematically capturing excess return,” Huemmer said. “In any asset class, it is crucial that you get compensated for the risk you are taking. This is a core tenet of FlexShares’ and all of Northern Trust Asset Management’s investment approach. Our research shows that by focusing on value in high yield, investors can make use of the diversifying benefits of high yield and potentially improve their risk-adjusted performance.”
FlexShares is seeing growing investor interest in dividend funds as a reliable source of income, and particularly those with a ‘defensive’ quality focus, which targets beta less than the market universe’s beta. Quality and yield have not been highly correlated historically, but the factor combination looks to produce compelling results as it serves to smooth each respective factor’s cycle.
Huemmer said its FlexShares International Quality Dividend Defensive Index Fund (IQDE) and FlexShares Quality Dividend Defensive Index Fund (QDEF) take advantage of FlexShares’ proprietary dividend scoring process while maintaining a focus on defensive quality.
“The key differentiating factor is how we measure dividend quality,” he said. “Our research shows that rather than focusing on historical dividend payments to evaluate their longevity, growth or payout ratio, it is more important to concentrate on the current financial health of a company. By evaluating management’s aggressiveness in their long-term capital decisions, the firm’s profitability and the state of its current cash flows, we gain better confidence that the dividend is well-covered and its potential to be increased over time.”
Northern Trust is currently bullish on global real estate and believes real estate offers some interesting opportunities right now. Real estate uses a lot of borrowed money, but with the Fed’s pivot to cut rates, a key headwind from that asset class has been removed. Furthermore, real estate has not been a top performer over the past few years, but Northern Trust believes this could be changing.
“Strategically, we believe global real estate is an attractive source of income and provides diversified risk exposure beneficial to most asset allocations,” Huemmer said. “The end of the rate hike cycle in the US and the potential for accommodative monetary policy around the globe should provide a tailwind to the asset class. By choosing a global real estate allocation instead of a domestic-focus strategy, investors should be able to increase the diversification of the asset class and potentially avoid some of the volatility US real estate has experienced since the Financial Crisis.”
Since real estate has a deep history with substantial depth in global markets, Huemmer said investors can evaluate factors similar to the research done across global equities.
“The FlexShares Global Quality Real Estate Index Fund (GQRE) offers a multi-factor approach to targeting high-quality, undervalued real estate securities that exhibit positive momentum and have the potential to outperform market weighted benchmarks over the long-term,” he said.
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