The Fidelity Dividend ETF for Rising Rates (FDRR), designed to perform in rising interest rate environments, is critiqued for its significant concentration in technology stocks (34.10%) and an elevated P/E ratio of 29x. This composition, particularly its reliance on high-growth, high-valuation tech companies, is seen as contradictory to its stated purpose, as such assets typically face multiple compression when rates rise. The analysis suggests FDRR's portfolio exposes investors to considerable valuation risk in a sustained higher interest rate environment, leading to a 'Sell' rating due to the misalignment of its strategy and holdings.
Whatever your outlook on the world is, there's probably an ETF that covers your views. Over the years, I've seen many investment themes come and go, so there's not much that surprises me any longer. But sometimes you come across a fund that catches your attention; one of those is the Fidelity Dividend ETF for Rising Rates (NYSEARCA:FDRR), which we're going to cover today. The issuer describes the ETF as follows: The Fidelity Dividend Index for Rising Rates is designed to reflect the performance of stocks of large and mid-capitalization dividend-paying companies that are expected to continue to pay and grow their dividends and have a positive correlation of returns to increasing 10-year U.S. Treasury yields. A positive correlation of returns to increasing 10-year U.S. Treasury yields is an interesting statement. We're going to find out what kind of dividend-paying stocks are in this ETF and how they might fare if we see a rising interest rate environment by comparing it to the 1970s, a decade of rapidly rising rates. But before we do that, let's start with the basics. Fidelity Dividend ETF for Rising Rates (FDRR) FDRR has a net expense ratio of 0.16%, which is on the low side for an ETF that covers a niche topic. The turnover rate is 27%, which is on the high side, and the transaction fees will likely add up over time. Sector Allocation The sector allocation looks interesting. Tech is leading the list with 34.10% of total assets invested. But the allocation to technology could be even higher, as tech stocks often can be found under consumer cyclical and communication, which are the third-largest and fifth-largest sectors by weight. Over the years, I've learned that over the short term, anything can happen in the stock market. But over the long term—which can be longer than most investors' patience—markets behave mostly rational. An environment of increasing interest rates usually isn't great for growth stocks or tech stocks. They tend to trade at elevated multiples and the more interest rates rise, the lower the earnings multiples fall. Future earnings (which for growth stocks are often far into the future) are discounted more heavily as the risk-free rate rises. A period of rising rates therefore often favors value stocks, companies with pricing power and defensive business models, that trade at low multiples and high dividend yields. "A bird in the hand is worth two in the bush" is the common theme in an environment of high rates. FDRR's high concentration in tech stocks is therefore surprising. What's not surprising, the allocation to financials, as it's the second-largest sector with a 13.62% weight. Financials could be one of the outperformers in a rising rate environment, but it depends on the health of the overall market. Banks and insurance companies usually benefit in times of increasing rates, as profit margins expand. Also, in recent times the P/E ratios have been well below the overall market, therefore multiple compression might be less severe, when the risk-free rate rises. Top Holdings FDRR holds 130 stocks, and the top 10 holdings represent 39.93% of total assets. That's quite concentrated, but it's not unusual for an ETF that covers a niche theme. The list of stocks is almost indistinguishable from the more popular ETFs nowadays. It contains most of the "Magnificent Seven," as well as known names like Eli Lilly and Johnson & Johnson. Just by looking at the top holdings, it becomes clear that FDRR's average P/E ratio might be elevated, so let's check it out. P/E Ratio Yahoo Finance claims the P/E ratio is 21.68, while the Wall Street Journal (WSJ) has it at 29.03. I usually rely on the WSJ numbers, as they tend to reflect the earnings multiple on a TTM basis quite accurately. A 29x P/E ratio is almost as high as the S&P 500, which is trading at 31x earnings right now. That's in the upper range of historical valuations—levels last seen in the late 1990s. What followed was the "lost decade," a decade of falling interest rates and stock prices. I wouldn't be comfortable holding a basket of stocks trading at elevated multiples during times of sustained rising interest rates, but as said before, over the short-term anything can happen. Risk-Free Rate and Stock Market Correlation Over the long term, there's a clear negative correlation between the risk-free rate and stock prices. The higher the interest rates, the lower the earnings multiples for stocks and the less investors care about profits far into the future. Why would you hold a stock with a meager 1% dividend yield, if inflation is high, and you could get 8% almost risk-free? So, the higher the earnings multiple you pay, the more exposed you are to downside risks, if we enter a period of sustained higher interest rates. Above is a long-term chart of U.S. interest rates. Interest rates tend to follow decades-long cycles. From the 1950s to the early 1980s, interest rates were rising, though not in a straight line. Then from the early 1980s to 2022, interest rates were declining from their high near 20% to almost 0%. What happened to stock market valuations during that timeframe? In the 1950s to the early 1960s, valuations rose from 7x P/E to a 20x P/E. Rising rates didn't hurt equity valuations, because after World War II, valuations were low to begin with. Then in the 1960s, valuations hovered around 20x earnings as interest rates further increased. During the 1970s, when interest rates crossed the 10% mark and inflation was rampant, investors started to panic and dumped their stocks at any price. When interest rates peaked in 1981, the average S&P 500 stock was trading at 7-8x earnings, or a 13% earnings yield. Right now, FDRR is trading at 29x earnings, or a 3.45% earnings yield. What would happen to this ETF, if we're in fact witnessing a "sea change," like Howard Marks described in his memo? The great equity returns of the last 40 years were partly achieved because of ever-declining interest rates. It led to cheaper capital, higher equity valuations, and higher margins and profits. I wouldn't bet on FDRR to outperform in an environment of ever-increasing rates. Given the valuations and exposure to tech, I rate it a "Sell". Comparison Against Other ETFs To my surprise, there is another ETF that covers the same theme, the ProShares Equities for Rising Rates ETF (EQRR). It seems like there's a demand from investors to hedge against rising rates, and usually when there's a demand, there's supply. Since 2022, at the time when interest rates started to rise, both ETFs performed well, but EQRR slightly outperformed on a total return basis. The best advice I can give to long-term investors is to stop focusing on short-term data and start looking at the bigger picture. The rising rates ETFs contain stocks that will likely suffer during times of sustained high-interest rates. The great performance of the last few years is because of the exposure to the Magnificent Seven, which will likely continue doing well as long as the bull market rages on. But having lived through different bull markets and bear markets, as long as the world is still cyclical, this will end one day. An environment of sustained higher interest rates could be a potential catalyst. Conclusion To me, FDRR feels like a contradiction. It's marketed as a hedge against rising rates, yet it's heavily concentrated in sectors that typically suffer when rates go up. There's certainly a case to be made for owning quality dividend payers in a rising rate environment, but at almost 30x earnings, the risk for multiple compression is high. Also, whether the largest holding, NVIDIA, could be described as a dividend stock is up for debate. In the current exuberant market environment, investors should carefully think about the risks they're taking on—especially in strategies designed to act as hedges. FDRR might have the right idea in theory, but the execution doesn't impress me. I rate it a "Sell." The Fidelity Dividend ETF for Rising Rates (FDRR) presents a significant contradiction between its stated investment objective and its portfolio composition. The fund, designed to outperform in a rising interest rate environment, has a 34.10% allocation to the technology sector and its top ten holdings, representing 39.93% of assets, are dominated by high-growth stocks like the 'Magnificent Seven'. This construction is fundamentally at odds with its mandate, as high-multiple growth stocks are historically vulnerable to rising discount rates. The fund's valuation appears elevated, with a P/E ratio of 29x, which is nearly as high as the S&P 500 and exposes investors to substantial multiple compression risk should interest rates continue to rise sustainably. While the fund has performed well since 2022, this is attributed to its exposure to the ongoing bull market in large-cap tech rather than any inherent rate-hedging characteristic. Furthermore, its high turnover rate of 27% may lead to increased transaction costs, eroding returns over time. The analysis concludes that FDRR is effectively a concentrated large-cap growth fund mislabeled as a rate hedge, making it poorly positioned for the very environment it purports to address.
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