We've seen so little of rising interest rates in the past few years that it's worth a review of how they affect various types of investments. Here's a six-pack of exchange-traded funds that could come under pressure when rates rise:
BMO Equal Weight Utilities Index ETF (ZUT): The utilities sector is notoriously sensitive to rising interest rates. Remember, utilities are a defensive sector that flourishes in uncertain times. If rates are rising, that signifies a growing economy.
BMO Monthly Income ETF (ZMI): A fund-of-fund ETF that contains some holdings that are vulnerable to rising rates – mid- and long-term corporate bonds, utility stocks and REITs, for example.
iShares Core Canadian Long Term Bond Index ETF (XLB): A very strong performer in recent years thanks to its focus on long-term bonds, or those maturing in 10-plus years. When interest rates fall, you get the biggest bang for your buck from long-term bonds. But when rates rise, long-term bonds get hammered.
iShares Canadian Government Bond Index ETF (XGB): Rising rates suggest financial market conditions where the extra security from holding government bonds is less appealing. If we see a steady move higher in rates, expect corporate bonds to outperform government bonds.
Vanguard FTSE Canadian Capped REIT Index ETF (VRE): Real estate investment trusts were hit hard when expectations of higher interest rates began to grow in the summer of 2013. Borrowing costs are one of the biggest business expenses a REIT incurs. On the other hand, higher rates suggest an economy that will help increase occupancy rates and justify rent increases.
TD Canadian Aggregate Bond Index ETF (TDB): Low-cost, broadly diversified bond ETFs such as this mix short- and longer- term bonds, as well as government and corporate bonds. In a rising rate world, short-term bonds would be less volatile.
The possibility of volatility ahead doesn't by any means make these ETFs a sell. Rather, investors should adjust their holdings to make sure each fund will meet both their short- and long-term needs. For example, adding some short-term corporate bonds to TDB might make sense. An ETF such as ZUT might continue to make sense as a generator of dividend income, even if the price comes under pressure.