An Overlooked ETF For Rising Interest Rates

The Federal Reserve boosted interest rates three times in 2017 and expectations are in place for further tightening in 2018. Rising interest rates could plague rate-sensitive sectors. As has been widely documented, utilities and real estate are among the groups that are usually negatively correlated to increasing borrowing costs.

Conversely, there are other assets that benefit from rising rates. In the U.S., investors often focus on the financial services and other cyclical groups as the Fed signals future rate hikes. Some international stocks are also worth considering as borrowing costs move higher.

Historical data indicate that Japanese financial services stocks can potentially benefit as U.S. rates move higher, which could propel the WisdomTree Japan Hedged Financials Fund DXJF this year.

Factors To Consider

As its name implies, DXJF is a currency-hedged exchange traded fund, meaning it was hamstrung by the weak dollar last year. Still, the fund managed to return more than 8 percent. That performance could improve if the dollar responds to Fed rate hikes in 2018. And historical data confirm Japanese financials respond well to Fed tightening.

“Simply speaking, negatively oriented regression coefficients are leading us toward RISING rate strategies, whereas more positively oriented coefficients are leading us toward FALLING rate strategies,” said WisdomTree in a recent note. 

From Nov. 30, 2012 through Sept. 30, 2017, the MSCI Japan Financials Index had a coefficient of negative 2.39 to U.S. interest rates. The number is negative but the trend is positive for investors.

The MSCI Japan Financials Index was more responsive to Fed tightening than benchmarks of U.S. bank stocks, according to WisdomTree data.

Another Idea

For investors who do not want to wait for the dollar to rebound but still want exposure to Japanese financials, the WisdomTree Japan SmallCap Dividend Fund DFJ is an idea to consider.

The $795.5-million DFJ is up nearly 32 percent over the past year and was one of the best-performing small-cap ETFs in 2017. DFJ allocates 10.6 percent of its weight to the financial services sector.

“Since the beginning of the Abenomics period, the performance of Japan’s equities has ebbed and flowed, but if one were to ask what were the best times to allocate toward Japan, the data here suggests that it was clearly during rising U.S. rate periods. Financials and exporters did very well, on average, over these periods, as did U.S. small caps,” according to WisdomTree.

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