With the Federal Reserve's December meeting just a few weeks away and expectations rising that the central bank will finally raise interest rates, certain sector exchange-traded funds are garnering renewed inflows. Predictably, that includes financial services ETFs.
And when the conversation is about financial services ETFs and the potentially positive impact rising rates have on those funds, the conversation must include regional bank funds such as the SPDR KBW Regional Banking (ETF) (NYSE:KRE).
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Focus On KRE
Home to $2.75 billion in assets under management, KRE is the largest and most heavily traded regional bank ETF.
As investors have come to terms with the notion that the Federal Reserve is increasingly likely to raise interest rates following its December meeting, 10-year Treasury yields are reflecting that view with a one-month surge of 11.4 percent. Predictably, KRE, an ETF that is positively correlated to rising rates, has benefited with a one-month gain of nearly nine percent.
In line with the market consensus, State Street Global Advisors (SSGA) believes theres still a chance the US Federal Reserve raises rates in 2015, which would usher in the first tightening cycle in about a decade. Although, if there is a hike, we dont believe rates will rise quickly. We do think investors should be prepared and focus on those parts of the market helped, not hurt, by higher rates, said SSgA, KRE's issuer, in a recent research piece.
Investors betting that financial services stocks will thrive in a rising rates environment would do well to bet on KRE rather than more diverse ETFs tracking the sector. Over the past 36 months, KRE's sensitivity to changes in 10-year Treasury yields is 0.24, or nearly double that of the Select Sector Financial Slct Str SPDR Fd (NYSE:XLF). XLF is the largest financial services ETF.
XLF is up 3.3 percent over the past month. Since the start of November, investors have poured $565.5 million into XLF, while allocating more than $241.5 million to KRE.
The financial sector and its related banking sub-industries show the most positive relationship to rising interest rates with regional banks exuding the strongest, added SSgA. The early part of the tightening cycle is especially constructive, as higher rates create more room for banks to increase the margins on their loans without stifling demand. Also, banks are just generally more willing to lend against a backdrop of improving economic conditions. So, to the degree the Feds moves reflect its confidence in the economy, wed expect lending activity to respond in kind.
Higher interest rates are seen as boons for regional banks' net interest margins, a key measure of profitability for these banks. This is how sensitive KRE is to rising rates. From February 2 through June 10, 10-year yields climbed 80 basis points, contributing to a gain of almost 19 percent for the regional bank ETF over that span.
Disclosure: Todd Shriber owns shares of XLF.
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