Forget Rate Hikes. These 3 Vanguard ETFs Could Be Better Positioned for What Comes Next.
At the beginning of the year, the market was pricing in multiple rate cuts from the Federal Reserve. Thanks in large part to the Iran war and the subsequent higher inflation that came with it, the market is now pricing in the likelihood of rate hikes before the end of the year.
At its July meeting, three of the Fed’s voting members wanted to raise rates by a quarter-point. Inflation looks like it will remain well above the target for the foreseeable future, and the decision may come down soon saying that rates aren’t restrictive enough.
A lot of people’s portfolios are still positioned for rate cuts, and that could be a problem. If conditions are about to get tighter over the next 6 to 12 months, it might be time to prepare for it.
Instead of trying to predict if or when the Fed’s next move will come, I’d rather own investments that can still work if rates move higher. Here are three exchange-traded funds (ETFs) I’d consider.
Image source: Getty Images.
No. 1: Vanguard Value ETF
The value factor has been a hot theme this year. The Vanguard Value ETF (VTV +0.54%) is outperforming the Vanguard S&P 500 ETF by more than 7 percentage points this year as the “Magnificent Seven” stocks lag the broader market badly.
Owning value stocks in higher-rate environments makes a lot of sense. The higher the borrowing cost, the less that investors are generally willing to pay for earnings further out into the future. That tends to hit growth stocks harder, but value stocks can hold up better because their valuations are already discounted.
Vanguard Morningstar Value ETF
Today’s Change
(0.54%) $1.21
Current Price
$226.40
Key Data Points
AUM
$257B
Dividend Yield
1.81%
Expense Ratio
0.03%
Top Holdings
JPM
3.50%
MU
3.45%
BRK-B
2.99%
The Vanguard Value ETF won’t necessarily be immune from a recession or a bear market. But its lower valuation and overweight-to-more-mature, profitable businesses can make it an attractive way to minimize some downside risk.
No. 2: Vanguard High Dividend Yield ETF
The case for investing in high-yield equities might be even better than that for value stocks. The Vanguard High Dividend Yield ETF (VYM +0.59%) takes a fairly broad approach to stock selection, but it overweights the areas of the market that should do comparatively well in higher-rate environments.
That includes value stocks for the reasons mentioned above. Its top sector weighting is financials, which actually benefit from higher rates because they improve their margins. And there are overweights in healthcare, consumer staples, and energy — all built to hold up well and take advantage of the current environment.
Vanguard High Dividend Yield ETF
Today’s Change
(0.59%) $0.97
Current Price
$164.97
Key Data Points
AUM
$99B
Dividend Yield
2.20%
Expense Ratio
0.04%
Top Holdings
AVGO
7.36%
JPM
3.82%
XOM
2.63%
The Vanguard High Dividend Yield ETF‘s current 2.2% payout may not really qualify as high, but the income component is a smaller part of the investment case here. The sector allocation makes it more attractive.
No. 3: Vanguard Short-Term Treasury ETF
This ETF would be more of the pure risk-off play and one of the immediate beneficiaries if the Fed were to hike rates.
The Vanguard Short-Term Treasury ETF (VGSH -0.02%) invests in government bonds with maturities of one to three years. It’s not Treasury bills, which are better designed for principal protection, but share price fluctuation should be minimal. Since these are short-term notes, a higher Fed Funds rate should be reflected in the yield on this ETF fairly quickly. It has a yield of 4.3%.
This gives investors the opportunity to earn meaningful yields while avoiding most interest rate sensitivity. The more the Fed decides to hike, the more income this ETF should generate.
Vanguard Scottsdale Funds – Vanguard Short-Term Treasury ETF
Today’s Change
(-0.02%) $-0.01
Current Price
$58.13
Key Data Points
AUM
$35B
Dividend Yield
3.81%
Expense Ratio
0.03%
Don’t build your portfolio around one Fed meeting
If your time horizon is 20 years or more, what happens with the Fed over the next few months is minor in the big picture. These ETFs can provide a short-term tilt based on current conditions, but you don’t want to significantly affect your long-term portfolio allocation. Moving a lot of money into short-term Treasuries without a concrete exit plan can damage long-term return potential.
Nonetheless, if you’re concerned about the impact of higher-for-longer rates, all three of these ETFs should be positioned to do well.
