The Attractiveness of High-Yield ETFs in a Rising Rate Environment: Balancing Dividend Sustainability and Risk-Adjusted Returns

In the wake of the Federal Reserve's aggressive rate hikes from 2022 to 2023—raising the federal funds rate from near zero to 5.25–5.50% by July 2023A timeline of the Fed's '22–'23 rate hikes & what …^[1]—investors have grappled with the dual challenges of preserving income and managing risk. High-yield ETFs, long a staple for income-seeking portfolios, have faced scrutiny as rising rates compress valuations and strain dividend sustainability. Yet, for those who navigate the nuances of fund structure and risk-adjusted returns, opportunities remain.

The Dividend Dilemma: Yield vs. Sustainability

High-yield ETFs like the Invesco KBW Premium Yield Equity REIT ETF (KBWY) and the Invesco S&P 500 High Dividend Low Volatility ETF (SPHD) have attracted attention for their compelling yields. KBWY, for instance, offers a staggering 9.28% yield7 Best Dividend ETFs Of 2025 – Forbes Advisor^[3], while SPHD and the Schwab U.S. Dividend Equity ETF (SCHD) provide more moderate but stable returns of 3.61% and 3.41%, respectively7 Best Dividend ETFs Of 2025 – Forbes Advisor^[3]. However, yield alone is not a sufficient metric. KBWY's dividend growth rate has turned negative (-3.04% over the past year7 Best Dividend ETFs Of 2025 – Forbes Advisor^[3]), signaling fragility in its payout model.

The sustainability of dividends in such funds hinges on the quality of underlying holdings. For example, the Fidelity High Dividend ETF (FDVV) filters out stocks with unsustainable payout ratios, prioritizing companies with a track record of dividend growthA timeline of the Fed's '22–'23 rate hikes & what …^[1]. Similarly, the Vanguard High Dividend Yield ETF (VYM) has maintained a consistent yield of 2.50%7 Best Dividend ETFs Of 2025 – Forbes Advisor^[3], reflecting its focus on financially robust firms. In contrast, REIT-heavy funds like KBWY face headwinds as rising rates elevate borrowing costs and depress real estate valuations7 Best Dividend ETFs Of 2025 – Forbes Advisor^[3].

Risk-Adjusted Returns: A Sharper Lens

While high yields are enticing, risk-adjusted returns provide a clearer picture of an ETF's value. The Sharpe ratio—a measure of return per unit of risk—reveals stark contrasts among top high-yield ETFs. During the 2022–2023 rate hike cycle, SPHD delivered a Sharpe ratio of 0.04A timeline of the Fed's '22–'23 rate hikes & what …^[1], indicating subpar risk-adjusted performance. VYM, by contrast, achieved a significantly better ratio of 0.91A timeline of the Fed's '22–'23 rate hikes & what …^[1], underscoring its ability to balance income with volatility management.

KBWY, however, fared poorly, with a one-year Sharpe ratio of -0.677 Best Dividend ETFs Of 2025 – Forbes Advisor^[3], reflecting its exposure to volatile real estate equities and declining net asset value (NAV). Over a five-year horizon, its Sharpe ratio improved to 0.227 Best Dividend ETFs Of 2025 – Forbes Advisor^[3], but this remains unimpressive relative to broader asset classes like U.S. Large-Cap Growth (QQQ), which boasts a 15-year Sharpe ratio of 0.987 Best Dividend ETFs Of 2025 – Forbes Advisor^[3]. These metrics highlight the importance of diversification and sector-specific risks in high-yield ETFs.

Navigating the Trade-Offs

The attractiveness of high-yield ETFs in a rising rate environment ultimately depends on an investor's risk tolerance and income needs. For those prioritizing stability, funds like VYM and SPHD—despite their lower yields—offer more predictable outcomes. VYM's 0.22% expense ratio7 Best Dividend ETFs Of 2025 – Forbes Advisor^[3] and its focus on broad market exposure further enhance its appeal. Conversely, aggressive income seekers might tolerate the volatility of KBWY, provided they hedge against interest rate risks or pair it with shorter-duration assets.

Morningstar analysts caution that investors must scrutinize ETF strategies, particularly those with exposure to high-yield bonds or mortgage REITs, which are acutely sensitive to rate changesBest High Dividend Yield ETFs to Watch in 2025^[2]. For instance, the VanEck Mortgage REIT Income ETF (MORT) and the SPDR Bloomberg High Yield Bond ETF (JNK) have historically underperformed during tightening cyclesBest High Dividend Yield ETFs to Watch in 2025^[2].

Conclusion

High-yield ETFs remain a double-edged sword in a rising rate environment. While they offer the allure of passive income, their sustainability and risk profiles demand careful evaluation. Investors must weigh the seductive pull of high yields against the cold calculus of risk-adjusted returns. As the Fed's policy trajectory remains uncertain, the key to success lies in aligning ETF choices with both income goals and risk tolerance—a lesson as old as investing itself.