With investors continuing to look for ways to hedge against potentially rising interest rates, we’ve been getting a lot of client questions about floating rate notes (FRNs), and have been seeing increased interest in the iShares Floating Rate Note ETF (NYSEArca: FLOT).
Since the beginning of the year FLOT has doubled in size, gathering $392mm in new inflows and bringing the total AUM to $789mm as of 3/1/2013.
As their name suggests, FRNs are investment grade bonds that pay a floating rather than fixed rate coupon. [Best ETFs for Floating Rate Bonds]
Since the coupon is adjusted with changes in interest rates (usually a short-term rate like the 1-month or 3-month LIBOR – see below), the bonds tend to be less sensitive to rate changes than securities with fixed interest rates. When LIBOR increases, (which tends to occur when the Fed is going through a tightening cycle) the coupons on floating rate notes will increase.
For this reason, we often see investors considering FRNs when they want to reduce their overall exposure to interest rate risk, but favor investment grade credit risk.