Editor’s Note: This article was updated to remedy inaccuracies regarding the BrandywineGlobal – High-Yield Fund.
After the pandemic-era hot run fueled by “easy money,” expect the volatility we’re seeing in the markets now to continue, as the U.S. Federal Reserve prepares to raise interest rates. It’s up for debate to what extent the Fed will raise rates. But whether it raises rates just three times, or six to seven times, as JPMorgan Chase (NYSE:JPM) CEO Jamie Dimon believes is possible, what does that mean for mutual funds?
Funds with heavy exposure to assets more sensitive to interest rate hikes could continue to drop. For example, funds with heavy tech exposure. Fixed-income funds may also see more declines, as higher rates means lower bond prices.
Yet other funds could stay resilient, or even thrive, as we carry on in a rising interest rate environment. In response to the Fed’s monetary policy changes, investors have been cycling out of growth, and into value plays. This bodes well for value-oriented funds. Also, higher interest rates is good news for bank stocks. Funds with a heavy concentration in financials could deliver solid performance as well.
As the Fed “returns to normal” with interest rates, investors need to adapt. If you are active in mutual funds, these seven are perfect names to move into, before rates go up:
- Avantis U.S. Small Cap Value Fund (MUTF:AVUVX)
- BrandywineGLOBAL-High Yield Fund (MUTF:BGHAX)
- Fidelity Series Intrinsic Opportunities Fund (MUTF:FDMLX)
- Delaware Ivy S&P 500 Dividend Aristocrats Index Fund (MUTF:IDAAX)
- Invesco Rochester Municipal Opportunities Fund (MUTF:ORNAX)
- Vanguard Equity Income Fund (MUTF:VEIPX)
- Vanguard Financials Index Fund (MUTF:VFAIX)
Mutual Funds: Avantis U.S. Small Cap Value Fund (AVUVX)
This small mutual fund, managed by American Century’s Avantis unit, invests in exactly as its name suggests. Thanks to the market’s strong performance, and the strong performance of stocks hard hit by the pandemic, it’s no surprise the fund beat major indices like the S&P 500, as well as its benchmark in 2021, with its total return of 40.17%. This performance also came in well ahead of its benchmark, the Russell 2000 Value Index. The Russell 2000 Value Index closed 2021 with a 28.27% return.
But even as it knocked it out of the park last year, that doesn’t necessarily mean this year will bring more modest returns for AVUVX. With the rate-hike fueled cycling out of richly-priced tech stocks, into value stocks? This fund, weighted more heavily toward financials (30%) and industrials (18%), and less toward tech (4%) could deliver solid performance again in 2022.
Among the 677 stocks held by the fund, major positions include Alcoa (NYSE:AA), Equitrans Midstream Corp (NYSE:ETRN), and Air Lease Corp (NYSE:AL). Avantis U.S. Small Cap Value Fund also holds positions in Chemours (NYSE:CC), Matador Resources (NYSE:MTRDR), and Triton International (NYSE:TRTN).
With a low expense ratio of 0.25%, its current forward yield at today’s net asset value, or NAV ($14.69 per share) comes in at -1.34%.
BrandywineGlobal-High Yield Fund (BGHAX)
Worried about what rising rates will do to bond mutual funds? Late last month, Barron’s tackled this question, offering some ideas of better plays as rates rise. BrandywineGlobal – High-Yield Fund was one of the names it recommended.
One of the main reasons for this pick was the shorter-than-average duration of its portfolio. Focusing on short-duration can mitigate some of the interest rate risk with fixed-income funds right now. So too, can focusing on funds with higher-yielding securities. BGHAX has you covered in that regard as well.
With 80% of its assets invested in high-yield corporate bonds, the fund owns debt securities from a wide variety of issuers. At today’s NAV ($10.85 per share), this fund, managed by Franklin Resources (NYSE:BEN), sports a 4.36% distribution rate.
Last year, the BrandywineGlobal High-Yield fund outperformed its main benchmark (the ICE BofA US High Yield Index). Already experiencing a selloff, once the Fed made it known that it planned to raise rates, this may make a great choice for income-focused investors. For them, it offers above-average yield. At the same time the risk of more capital losses may be minimal, compared to funds holding investment-grade debt securities.
Mutual Funds: Fidelity Series Intrinsic Opportunities Fund (FDMLX)
Managed by Fidelity, FDMLX is a mid-cap value mutual fund. Last year, it delivered returns in-line with the S&P, and with its main benchmark, the Russell 3000. If the market remains volatile due to interest rate increases, it may not exactly set the world on fire, performance-wise, during 2022.
However, like I mentioned above, value could outperform growth during this environment. This may make it one of the funds to keep on your watchlist. Sure, there are scores of other names out there with this same investment approach.
Yet with an expense ratio of just one basis point (0.01%), how many can beat it on fees? Intrinsic Opportunities is unique as well in that it has a fairly high allocation to international equities. 38.24% of its portfolio consists of non-U.S. stocks. Foreign names include Itochu Corp (OTCMKTS:ITOCY) and JD Sports Fashion PLC (OTCMKTS:JDSPY).
Domestic equities in its portfolio include health insurers like Anthem (NYSE:ANTM) and Aflac (NYSE:AFL). In addition, industrial names like Lear (NYSE:LEA) and Mosaic Co. (NYSE:MOS). With a forward yield of 2.51%, and a 5-star rating from Morningstar (NASDAQ:MORN), consider it another high-quality fund to move into, as interest rates move higher after their pandemic-era move to historic lows.
Delaware Ivy S&P 500 Dividend Aristocrats Index Fund (IDAAX)
Besides value funds, another space that could perform relatively well over the next twelve months is high-quality stocks. In particular, the so-called “dividend aristocrats.” What is a dividend aristocrat? These are the venerable companies that have increased their dividends at least 25 years in a row.
There are many ways to invest in dividend aristocrats. But if you’re looking for a mutual fund that tracks their performance, IDAAX is a vehicle to consider. Managed by Macquarie Group’s Ivy Investments unit, this index fund tracks the performance of the S&P 500 Dividend Aristocrats Index. This index holds each aristocrat equally within the portfolio, instead of weighing them by market capitalization.
Well-known aristocrats held by the index (and in turn, this fund) include Sysco (NYSE:SYY), Archer-Daniels Midland (NYSE:ADM) and Exxon Mobil (NYSE:XOM). This fund also holds roughly equal positions in some lesser known S&P 500 dividend aristocrats. These include Albemarle Corp (NYSE:ALB), People’s United Financial (NASDAQ:PBCT) and West Pharmaceutical Services (NYSE:WST).
In 2021, according to Morningstar, it delivered a 25% total return. That was in line with the overall market during the year. Given the market’s current rockiness, I wouldn’t expect it to make another 25% move higher this year. Yet as it’ll likely see less volatility than the market overall. It could also outperform, as sentiment shifts away from growth and towards value. Put it all together, IDAAX may be a fund worth buying today. It may wind up delivering more than satisfactory returns through the rest of the year.
Mutual Funds: Invesco Rochester Municipal Opportunities Fund (ORNAX)
Along with BGHAX, ORNAX was another of the bond mutual funds recommended by Barron’s as a buy ahead of rate increases. The Invesco (NYSE:IVZ) managed fund, as you can tell from its name, invests in municipal bond. Specifically, lower-rated municipal bonds. With these lower credit ratings of course comes higher yields.
The fund holds a diverse portfolio of state and local-level municipal debt securities. These include bonds issued by California, New York City, and San Francisco. Its list of top holdings also includes tobacco settlement bonds issued by California and the District of Columbia.
At today’s NAV ($8.07), the Municipal Opportunities Fund has a trailing twelve month (TTM) yield of 4.32%. Sure, that may not sound like “high yield,” at a time of more than 6% inflation. Yet keep in mind that muni bonds are exempt from federal income taxes. Depending on your tax bracket, its after-tax yield may be higher than with taxable corporate bonds.
Also, its higher yield may reduce further downside, as bonds and bond funds continue to sell-off in the face of rising rates. With its municipal bond focus, and its potential to perform better than investment-grade bond funds in 2022, investors focused on income rather than capital growth may want to consider buying ORNAX.
Vanguard Equity Income Fund (VEIPX)
Above, we’ve talked about how value and high-yield could hold up as rates rise. But in terms of sectors, one that could perform well as the Fed changes policies is the financial sector. Banks, insurance companies, and other financial institutions have been challenged over the past few years by super-low interest rates.
Yet as interest rates get it on the long road back to what you could consider “normal” levels? In turn, financials may deliver stronger earnings in the quarters ahead. Among mutual funds, you have many options for adding exposure to financials to your portfolio. One of the best ones is The Vanguard Group’s Equity Income Fund.
Sure, VEIPX is not specifically a financials-focused fund. It’s a large-cap value fund. However, while top holdings in its portfolio include healthcare plays like Johnson & Johnson (NYSE:JNJ), and consumer staples stocks like Procter & Gamble (NYSE:PG), around 21.7% of the portfolio is invested in financials. This includes positions in JPMorgan Chase, Bank of America (NYSE:BAC), and Morgan Stanley (NYSE:MS).
Featuring a low expense ratio (0.28%), as is standard with Vanguard, the fund also has a trailing-twelve month yield of 2.35%. Underperforming the overall stock market in 2021, it could outperform it during 2022.
Wrapping up this gallery, let’s take a look at another Vanguard-managed fund. This time, focused on financials, rather than just heavily weighted toward them. VFAIX, like VEIPX, has a low expense ratio. In this fund’s case, just 10 basis points, or 0.10%.
Among the 400 stocks in its portfolio, its top ten holdings include JPMorgan Chase, Berkshire Hathaway (NYSE:BRK-A,NYSE:BRK-B), Wells Fargo (NYSE:WFC), and BlackRock (NYSE:BLK). Rising in value by 29.1% over the past year, it outperformed the S&P 500, and in-line with its benchmark (MSCI US IMI Financials 25/50).
Again, financial stocks stand to benefit from higher interest rates. This points to another year of strong returns for the sector this year. In fact, financials have already outperformed other sectors, year-to-date. This fund is up 4.03% year-to-date. That’s on par with how financial stocks in the S&P 500 have performed since the first trading day of 2022 (4.1%).
Sure, with the market now bracing for higher rates, much of the positive impact of them may already be reflected in financials. This could mean lower returns for the sector (and this fund) this year compared to last year. That said, looking at it on a relative basis? Financials appeared primed to outperform past tech and other growth plays next year. By buying VFAIX, you can give your portfolio exposure for this change in market trends.
On the date of publication, Thomas Niel did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
Thomas Niel, a contributor for InvestorPlace.com, has been writing single-stock analysis for web-based publications since 2016.