3 ETFs That Benefit From Higher Interest Rates

Bryan Armour: Interest rates were extremely low for a long time. So long so that a federal-funds rate near 0% felt normal. Foreign sovereign debt was issued with negative yields; Austria even sold a 100-year bond with a 0.85% coupon that matures in 2120. However, history tells us near-zero interest rates are far from normal.

Since 1954, there have been 123 months where the effective federal-funds rate was below 0.60%. All 123 observations came after 2007. Prior to 2007, there were more months with a federal-funds rate above 15% than there were below 1%. That is to say, the current rate of 5.5% is high but not even approaching historical extremes.

Since the Fed began hiking interest rates in earnest, bond traders have continuously had to push back their predictions of when the first rate cut would take place. The Fed remains hawkish. The jobs market continues to run hot. U.S. GDP has beaten forecasts. Investors don’t need to fight the Fed—there is money to be made should rates stay higher for longer. Today, I share three ETFs that can do just that.

First, it should come as no surprise that bonds perform better when rates are higher. Not only are yields higher, but rates are more likely to drop at current levels, which would benefit bond prices.

3 ETFs That Benefit From Higher Interest Rates

1. iShares U.S. Treasury Bond ETF GOVT
2. Invesco S&P 500 Quality ETF SPHQ
3. Avantis U.S. Large Cap Value ETF AVLV

For that reason, the first ETF on my list is iShares U.S. Treasury Bond ETF, ticker GOVT. There’s no need to bet on short- or long-maturity bonds: GOVT gives you access to all maturities. This is a balanced approach that will keep interest income churning for years to come, regardless of what happens to interest rates.

Another winning higher-for-longer strategy is quality. High-quality stocks have proven resilient in all interest-rate highers. That’s why the second ETF on my list is Invesco S&P 500 Quality ETF, ticker SPHQ. SPHQ favors stable, profitable companies over those that rely on debt financing or that aggressively grow their assets. It ranks S&P 500 companies by their quality score and picks the highest-ranking 100. It weights selected holdings by a combination of their market cap and quality score, steering the portfolio further toward quality while also tying weights to market prices. Quality tends to come at a premium, but SPHQ stays well-grounded. It’s among one of the highest-quality ETFs we rate, but it still maintains its spot in the large blend Morningstar Category, not large growth like other top quality strategies. This is important because—spoiler alert—value tends to outperform growth when interest rates move higher. SPHQ gives investors the best of both worlds—high quality without a heavy growth tilt. That’s one of the reasons its return has ranked in the top-five percentile funds in its category over the past 10 years and should continue to be a winner for investors.

As the spoiler alert foreshadowed, my final ETF focuses on value stocks, while also tapping into higher-quality companies than most value peers. Avantis U.S. Large Cap Value ETF, ticker AVLV, looks for companies that are both cheaply priced and profitable, selecting the top 25% of U.S. stocks based on the combination of those two metrics. AVLV’s portfolio looks unconventional in some ways. It can hold growth stocks if their profits justify their relatively steeper multiples. For example, Apple AAPL has landed among the fund’s top 10 largest holdings since the fund’s launch in late 2021. But it still retains an emphasis on cheaper companies, with its average valuation tending to fall below its average large value Morningstar Category peer. AVLV has a short but successful track record, beating the Russell 1000 Value Index and its average large-value peer since its 2021 inception. Its combination of value and profitability should pair well with interest rates that stay higher for longer.

Watch “3 Best New ETFs of 2023″ for more from Bryan Armour.