Exchange traded fund investors can turn to alternative strategies to prepare their portfolios for a rapidly evolving market environment.
In the recent webcast, Inflation and Rising Rates: An Advisor’s Playbook For 2022, Scott Peng, founder and CEO/CIO of Advocate Capital Management, warned of the perfect storm for rising interest rates, and highlighted the unprecedented fiscal and monetary stimulus measures, huge fiscal deficits, government bond supply, pent-up consumption demand, inflation, and the Federal Reserve’s hawkish policy outlook. Meanwhile, the economy has seen labor force participation rates fall to their lowest level since the 1970s, and disrupted supply chains with transportation costs have spiked from a combination of high bookings and logistic logjams.
Beyond that, investors exposed to U.S. Treasuries face yields that are too low compared to inflation, which makes many vulnerable to greater risks, especially with a rising interest rate environment ahead and few potential rewards to show for the heightened risks.
Alternatively, Peng argued that investors should consider a rising rate hedged strategy like the Advocate Rising Rate Hedge ETF (RRH), an active fund that uses Treasury securities and derivatives should long-term yields increase faster than short-term yields. The strategy is a multi-asset ETF that seeks to generate capital appreciation during periods of rising long-term interest rates, specifically interest rates with maturities of five years or longer.
Peng expressed belief that the strategy could help hedge rising rates and inflation while offsetting lower performance of various assets classes that are vulnerable to rising rates. This alternative asset should help improve portfolio characteristics or diminish risks associated with higher rates.
The actively managed RRH seeks to achieve its investment objective primarily by investing in a combination of U.S. Treasury securities; forwards, futures, or options on various currencies; long and short positions on the short and long end of the Treasury or swap yield curve via futures, swaps, forwards and other over-the-counter derivatives; long and short positions on equity indexes and/or investment companies, including ETFs; and commodity futures and options.
In addition, Jose Cherian, senior product manager at Vident Financial, highlighted the opportunity of real estate investments as another means of staying ahead of inflation. Real estate investment trusts are often seen as a great way to diversify a portfolio.
“Over a 10-year period, REITs have typically displayed a relatively lower correlation to equities, bonds, and commodities than other asset classes,” Cherian said.
“Potentially higher dividends may make REITs an attractive complement or alternative to bonds as a source of income,” Cherian added.
Vident Financial has come out with the U.S. Diversified Real Estate ETF (NYSE Arca: PPTY). The ETF adheres to four main factors when constructing a diversified portfolio, including location, property type, leverage, and governance.
The location factor refers to a key driver of real estate performance. Stable targets are used to diversify geographic exposure while favoring dynamic, high-growth locations. PPTY’s geographic targets increase exposure to relatively attractive retail locations such as New York City, Washington, D.C., and Los Angeles.
Property type is based on the fact that differences between property types matter, so fixed allocations seek to ensure diversification and balance. A traditional market cap-weighted indexing methodology focuses on retail, followed by communication, whereas PPTY’s more balanced approach takes an overweight position to residential, office space, and industrial REITs.
The leverage factor corresponds to the responsible use of leverage to enhance returns, but excessive debt creates unnecessary risk, especially during economic downturns. PPTY seeks to reduce allocations to companies with high debt in favor of firms with strong balance sheets.
Lastly, governance covers companies with significant governance risks, which are excluded from the portfolio. The index utilizes two criteria: external management and low free float percentage.
Financial advisors who are interested in learning more about strategies for inflation and rising rates can watch the webcast here on demand.