Just a few months ago, allocating to equity strategies designed to thrive in rising rate environments wouldn’t have been a priority for many investors. However, markets shift rapidly and the ProShares Equities for Rising Rates ETF (EQRR) is back in style.
EQRR tries to reflect the performance of the Nasdaq U.S. Large-Cap Equities for Rising Rates Index, which selects 50 components from a universe of the 500 largest companies based on market capitalization listed on the U.S. exchange that have historically outperformed during periods of rising interest rates.
On a quarter-by-quarter basis, the underlying index will target the five most interest rate sensitive industry sectors out of the original universe based on the correlation of weekly sector performance to weekly percentage changes in 10-year U.S. Treasury yields over the prior three-year period. The sector with the highest correlation will have a 30% position in the index, followed by 25% for the second highest, 20% for the third highest, 15% for the fourth highest, and 10% for the fifth highest.
“Certain equity market sectors are more sensitive to interest rates than others and can rise or fall as rates change. There are also stocks within these rate-sensitive sectors that have a greater tendency to demonstrate positive or negative results as rates move than others. These different sensitivities to rates create an opportunity,” according to ProShares.
With Rates Climbing, the Timing Is Perfect for ‘EQRR’
Currently, EQRR allocates more than 63% of its combined weight to financial services and energy stocks – two of this year’s best-performing sectors.
Historically speaking, rising rates are a boon for bank stocks. With rates still low by historical standards, some market observers believe Treasury yields can continue climbing, potentially benefiting KBWB in the process.
Within EQRR, each sector will hold 10 stocks for inclusion, with each stock exhibiting the strongest correlation of over performance compared to the increase in 10-year U.S. Treasury yields based on a weekly observation over the past three years. If there aren’t enough large cap stocks that meet the requirement, then the index may include top mid cap stocks.
Investors worried about the potential negative effects of rising rates on the equity side of their investment portfolio may look to a targeted ETF strategy. EQRR was the first U.S. stock ETF designed to outperform traditional large cap indices like the S&P 500 when interest rates rise.
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The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.