Not So Sensitive: An ETF Designed to Deal With Rate Hikes

Sensitivity can be a positive trait. Except for when sensitivity is applied to financial markets and an asset's perceived weakness in the face of imminent changes in the Federal Reserve's interest rate policy.

This is a scenario exchange traded funds investors have had to deal with countless times this year. Just look at the struggles by and outflows from real estate investment trust (REIT) ETFs and, until recently, the sagging performances of utilities funds.

Fortunately, ETF issuers have been developing new products specifically geared toward coping with rising rates. We recently highlighted an equity-based ETF designed to profit from dollar strength, the byproduct of markets' anticipating higher interest rates. Today, we examine the PowerShares S&P 500 ex-Rate Sensitive Low Volatility Portfolio XRLV, a fund aimed delivering investors exposure to sectors that should thrive as rates climb. 

One way of looking at the PowerShares S&P 500 ex-Rate Sensitive Low Volatility Portfolio is that the rookie ETF is the interest rate play on the popular PowerShares S&P 500 Low Volatility Portfolio SPLV because the former employs some of the volatility-damping strategies that have made the latter a hit with investors.

While SPLV holds the 100 S&P 500 members with the lowest trailing 12-month volatility, XRLV's holdings are the 100 S&P 500 stocks “that exhibit both low volatility and low interest rate risk,” according to PowerShares. 

XRLV, which debuted in April, tracks the S&P 500 Low Volatility Rate Response Index, an index “designed to include stocks exhibiting low volatility characteristics, after removing stocks that historically have performed poorly in rising interest rate environments.”

So while it may come as a surprise to some that SPLV, the low volatility ETF, is significantly overweight financial services stocks, that trait is not a surprise when it comes to XRLV. XRLV devotes almost 34.2 percent of its weight to that sector, nearly 1,500 basis points ahead of industrials, the fund's second-largest sector allocation.

What is important is not just that XRLV has a hefty financial services weight, but rather what types of financial stocks the ETFs. Remembering that this is a fund designed to thrive as rates rise, REITs have scant representation among XRLV's 33 financial holdings. Twenty of the ETF's financial services holdings are either insurance providers or regional banks, the financial services sub-sectors most positively levered to rising interest rates. 

Critics could allege that XRLV is a gimmicky ETF and that investors would be better off with a prosaic, old guard broad market ETF. That criticism would be misinformed. Since XRLV debuted on April 9, 10-year Treasury yields have climbed almost 15 percent while the ETF is up three percent. XRLV's returns since inception are seven and a half times superior to the S&P 500 over that span.

With that, it probably is not surprising that XRLV has attracted nearly $101 million in assets, making it one of the more successful new ETFs to debut this year.