Take it from someone that’s analyzed and covered exchange traded funds for about 15 years: ETFs don’t always behave as their names imply.
There are occasions when low volatility ETFs battle, well, elevated volatility. Likewise, there ETFs purporting to be high-dividend strategies that, in reality, don’t sport big dividend yields. It’s not that these products are being misrepresented by issuers, but these scenarios are reminders that there will times when certain strategies don’t perform as expected.
Generally speaking, when ETFs act out of character, it’s in short-term windows. For example, low volatility funds usually do their jobs over the long-term.
On the other hand, rising interest rates are shining a light on a specific exchange traded fund that’s doing exactly what’s supposed to: The ProShares Equities for Rising Rates ETF (EQRR). EQRR, which tracks the Nasdaq U.S. Large Cap Equities for Rising Rates Index, is up 0.27% year-to-date. These days, that’s something to brag about, particularly when measured against the S&P 500’s year-to-date loss of almost 16%.
EQRR Functioning as Expected
EQRR’s year-to-date gain, albeit modest, is confirmation the fund is doing what it’s supposed to do and that is provide investors with equity-based shelter from rising interest rates. Interestingly, this is old hat for the ProShares ETF.
“EQRR's underlying index, Nasdaq U.S. Large Cap Equities for Rising Rates Index, has significantly outperformed the S&P 500 after the yield on the 10-yr Treasury started rising during the summer of 2020,” according to ProShares research.
In discussing EQRR with clients, advisors should emphasize that this is not a diverse ETF at the sector level. It’s rather concentrated, which is a talking point unto to itself for novice clients because many of them don’t know, as advisors do, that some sectors are more positively correlated to rising 10-year Treasury yields than others.
EQRR’s ““ index first targets the five sectors that have had a tendency to outperform when rates rise – those sectors that have demonstrated the highest correlation with the 10-year U.S. Treasury yield over the prior 36 months,” adds ProShares.
Boiling it down even further, EQRR allocates nearly two-thirds of its weight to the energy, financial services and materials sectors – the second of which is a surprising laggard this year, making the fund’s 2022 showing all the more remarkable.
While the fund has sector risk, single-stock risk is relatively tame as its largest holding commands a weight of 3.49%. On those notes, it’s worth discussing with clients that there are good reasons why six of the 11 GICS sectors are excluded from EQRR. Put simply, those groups usually disappoint when rates climb.
“EQRR has outperformed the S&P 500 as the 10-year Treasury yield has risen, and sector allocation and stock selection components were both key contributors to the fund's performance,” notes ProShares.
Again, EQRR isn’t setting the equity market ablaze this year. Then again, with so many indexes flirting with or in bear markets, not much is.
The fund isn’t glamorous at the moment, but it is proving dependable and that trait is enviable in the current market environment. At the end of the day, EQRR is framed as “a complement to a core equity allocation for a rising rate environment.” And it’s doing its job this year. That’s what really matters.
Related: Floating Rate Notes Aren’t Perfect