The Federal Reserve is expected to raise interest rates for the first time this year in December. While the specter of higher rates could initially pressure income-generating sectors and asset classes, income investors would do well to remember that the benchmark U.S. interest rate is still low by historical standards and that the Fed insists that the trajectory of future rate hikes is likely to be measured, if not downright slow.
Some exchange-traded funds are vulnerable to higher interest rates while other income ETFs have the ability to continue delivering yield with the potential for capital appreciation as borrowing costs climb.
Investors researching income ETFs holding common stocks would do well to steer clear of those funds with heavy utilities exposure, because the utilities sector is among the most negatively correlated to hawkish changes in Fed policy. Conversely, funds holding common stocks while focusing on cyclical sectors can keep delivering while rates rise because cyclical stocks — think industrials and materials, among others — historically perform well when rates rise.
Likewise, there are some popular income-generating asset classes that are viewed as vulnerable to higher interest rates — think real estate investment trusts (REITs) and preferred stocks.
Here are some income ETFs lobbing off yields of 5% or more, a couple of which could prove sturdy in the face of the Fed’s whims.
Income ETFs to Buy: FlexShares Morningstar Global Upstream Natural Resources Index Fund (GUNR)
Expense ratio: 0.46% per year, or $46 on a $10,000 investment.
Yield: 5.1%
The FlexShares Morningstar Global Upstream Natural Resources Index Fund (NYSEARCA:GUNR) checks two of the boxes mentioned earlier.
First, GUNR is an income ETF comprised of common stocks hailing from highly cyclical sectors. Materials and energy names combine for over 64% of this income ETF’s weight.
Second, GUNR’s credentials are enhanced with a trailing-12-month dividend yield north of 5.1%, according to issuer data.
As its name implies, GUNR is a global fund, but its geographic exposures are predominantly developed markets, with the U.S., U.K. and Canada combining for two-thirds of the ETF’s lineup. The $2.86 billion GUNR is more than five years old and is home to 123 stocks.
Perhaps the biggest risk to GUNR’s near-term upside is the dollar … as in a strong dollar has historically stymied GUNR. In the time the ETF has been trading, 2013 was the only year in which GUNR and the U.S. Dollar Index moved somewhat in tandem. Typically, their annual performances are opposite.
Top holdings of GUNR include Exxon Mobil Corporation (NYSE:XOM) and Monsanto Company (NYSE:MON).
Unrelated, but still good news: FlexShares recently trimmed the annual fee on GUNR to its current 0.46%.
Income ETFs to Buy: Master Income ETF (HIPS)
Expense ratio: 1.43%
Yield: 7.7%
Master Income ETF (NYSEARCA:HIPS) does not get a lot of press, but for investors who can stomach the fee, which is high in the ETF universe, HIPS could be useful satellite, income-generating position.
This income ETF uses a multi-asset approach, something seen with several other high-yield ETFs, but the result with HIPS is tempting as the ETF had a distribution rate of 7.7% at the end of October, according to issuer data.
Among the 280 holdings in HIPS are high-yielding common stocks, REITs, master limited partnerships (MLPs), business development companies and closed-end funds — an asset class favored by many advanced income investors.
Familiar names on HIPS’s roster include Williams Companies Inc (NYSE:WMB), Blackstone Group LP (NYSE:BX) and Invesco Ltd. (NSYE:IVZ). HIPS is up nearly 5% year-to-date, but underscoring the sensitivity of some of this income ETF’s holdings to rising interest rates, the fund is down 6.7% over the past 90 days — a period in which Treasury yields have moved higher.
Income ETFs to Buy: Global X SuperDividend Emerging Markets ETF (SDEM)
Expense ratio: 0.65%
Yield: 5.1%
A trailing-12-month dividend yield of almost 5.1% speaks to the Global X SuperDividend Emerging Markets ETF‘s (NYSEARCA:SDEM) credibility as an income ETF.
There are different ways to skin the emerging-markets dividend cat via ETFs, but one of the more reliable approaches includes exposure to Russia that is overweight relative to the MSCI Emerging Markets Index.
This is not an endorsement of the Kremlin or the regime in charge, but Moscow takes a heavy-handed approach to ensuring that Russia’s state-owned firms throw off juicy dividends because the government is usually the largest shareholder in these companies. So, indirectly, Russian President Vladimir Putin is doing investors a favor when they decide to invest in an income ETF like SDEM.
Russian stocks account for nearly 12% of SDEM’s weight, the third-largest country exposure in the fund behind China and Brazil, two other staples of emerging-markets dividend ETFs.
Making SDEM an even more alluring play is that it pays its dividend monthly, a rarity among international dividend ETFs.
At the time of this writing, Todd Shriber did not own any of the aforementioned securities.
