Since the Great Recession and financial crisis of 2008, the U.S. Federal Reserve has maintained a prolonged period of extreme quantitative easing. A large part of this program was steadily to reduce the Fed Funds rate, which is the interest-rate benchmark that banks charge one another for loans, to zero. Additional monetary easing measures taken by the Federal Reserve include monthly bond buying, which has been concluded.
But as of yet, interest rates remain at historically low levels. This zero interest rate policy has helped over-leveraged companies and consumers pay off their debts more easily. The flip side of the Federal Reserve’s easy money policies is that savers receive little interest, and future inflation could be severe. As the economy steadily recovers, the Federal Reserve has signaled a rate hike may happen as soon as December.
Here are a few mutual funds that predominantly invest in these areas of the market, which will be major beneficiaries from rising interest rates.
Markets Are Pricing in a Rate Hike
Federal Reserve chair Janet Yellen has signaled that the Federal Reserve finally might raise rates in December, which would represent the first rate hike in the United States since 2006. If the Federal Reserve does raise rates next month, there will be winners and losers. Among the losers will be rate-sensitive sectors such as utilities and real estate investment trusts that heavily use debt in their capital structures. But investors should take note of the winners of rising interest rates – primarily financial stocks such as banks and insurance companies.
The reason is because financial institutions earn interest spreads between the money paid out on deposits and the money earned on lending. Spreads are bigger for longer-dated loans than they are for short-term deposits; as a result, the net interest margin expands when interest rates rise. This is why the financial sector stands to be the biggest winner in a rising rate environment.
Here are three mutual funds that will benefit from higher interest rates:
Emerald Banking and Finance Fund Investor Class (FFBFX)
Fidelity Select Insurance Portfolio (FSPCX)
Hennessy Small Cap Financial Fund Investor Class (HSFNX)
The Emerald fund’s top three holdings are Bank of the Ozarks, PacWest Bancorp and SVB
Financial Group. The Fidelity fund’s top three holdings are AIG
, MetLife and Ace Ltd., while the Hennessy fund takes a unique approach in that it primarily invests in small-cap stocks with market capitalizations of less than $1.5 billion. Its top three holdings are Banner Corp., Hingham Institution for Savings and Provident Financial Services.
The three mutual funds listed each typically invest at least 80% of its assets in stocks of companies primarily engaged in the banking or financial services industries. These three funds are appropriate for retail investors, as they each hold minimum initial investments of $2,500. Also, they have performed very well this year, in excess of the S&P 500, which has returned just 2% year-to-date. This is why the three hold at least four-star ratings from Morningstar. Moreover, all three funds carry modest expense ratios below their peer averages.
Since the economic recovery began in the United States in the aftermath of the Great Recession, the Federal Reserve has reiterated a number of economic data points needed to reach certain levels, in order for interest rates to be raised. These include satisfactory levels of employment, a recovering housing market and modest inflation. This year, that threshold finally has started to be crossed.
Economists widely expect a rate hike next month. Investors should take note of this as well as the types of stocks that tend to do well in a rising-rate environment. The three mutual funds listed above predominantly invest in equities in the financial sector. All three have outperformed so far this year, on expectations of a coming interest rate hike. As such, these mutual funds should outperform once interest rates begin to rise.