Smart Beta ETFs for Rising U.S. Interest Rates

Thus far in 2017, iShares Edge MSCI Minimum Volatility USA ETF (USMV) and PowerShares S&P 500 Low Volatility Portfolio (SPLV) have shed a combined $1.3 billion assets. Despite the exposure differences – for example USMV has sector constraints not employed for SPLV — both offer relatively strong exposure to higher-dividend-yielding stocks relative to the S&P 500 index. As the Fed raises rates further this year, a rotation away from these “bond proxies” may occur.

CFRA has Overweight rankings on both ETFs, based on a combination of holdings-level analysis and fund attributes.  More specifically, SPLV and USMV currently earn favorably low risk consideration attributes in our research, which is consistent with the downside protection investors should seek out from a lower-volatility product.

In April 2015, PowerShares S&P 500 ex-Rate Sensitive Low Volatility Portfolio (XRLV) came to market and has $220 million in assets. Similar to the $6.5 billion SPLV, XRLV focuses on the 100 least volatile stocks in the S&P 500 index. But the smaller ETF first excludes stocks that historically have performed poorly in rising interest rate environments. Examples of stocks inside SPLV that do not make the cut for XRLV, include utilities Dominion Resources (D) and Southern Co (SO).

Rather, those and other utilities are replaced in XRLV by other S&P 500 constituents, including industrials stocks Ametek (AME) and J.B Hunt Transport Services (JBHT). Both are CFRA buy recommendations that have medium CFRA qualitative risk considerations.

In 2017, XRLV is up 5.9%, ahead of SPLV’s 5.1%, highlighting the importance of understanding the construction of these index-based products.