Rising interest rates have pushed fixed income investors to allocate toward shorter durations, but floating rate note exchange traded funds could be a better fit.
Floating rate ETFs have been outperforming short-duration bond ETFs as interest rates begin to rise after hitting a three decade low.
ETFs in this category include iShares Floating Rate Note Fund (NYSEArca: FLOT), SPDR Barclays Capital Investment Grade Floating Rate (NYSEArca: FLRN) and Market Vectors Investment Grade Floating Rate (NYSEArca: FLTR).
These ETFs are comprised of U.S. dollar-denominated, investment grade floating rate notes.
Floating rate notes come with a variable interest rate that adjusts to the prevailing interest rate. Consequently, the securities help shield investors against interest rate hikes – a rising interest rate corresponds with lower bond prices. However, floating rate notes come with lower yields than fixed notes of the same maturity.
Consequently, the floating rate ETFs have very short effective durations. The iShares FLOT ETF has an effective duration of 0.13 years and comes with a 0.37% 30-day SEC yield. FLRN has a duration of 0.12 years and a 0.47% 30-day SEC yield. FLTR has a 0.12 years duration and a 0.48% 30-day SEC yield.
The effective duration is a measure of the sensitivity of a bond price to changes in interest rates. The greater the duration the greater the interest rate risk. For example, 2 year duration would translate to a 2% dip in the bond ETF’s price if interest rates were to increase 1%. [New High-Yield Bond ETF Protects Against Rising Rates]
For more information on fixed income assets, visit our bond ETFs category.
Max Chen contributed to this article.