In an attempt to hedge the negative effects of a rising rate environment, more investors are turning to floating rate bond exchange traded funds as a way to maintain their capital while squeezing out some extra cash on the side.
For instance, the iShares Floating Rate Bond ETF (NYSEArca: FLOT) has gathered $2.8 billion in assets over the past year, according to ETF.com data. [Investors Flock to Floating Rate ETFs on Interest Rate Concerns]
Floating rate notes, like the name suggests, have a floating interest rate. Specifically, the notes’ have a so-called reset period with interest rates tied to a benchmark, such as the Fed funds, LIBOR, prime rate or U.S. Treasury bill rate.
Due to the short reset period, the iShares Floating Rate Bond ETF has an effective duration of 0.15 year – a 1% increase in interest rates would translate to about a 0.15% decline in the ETF’s performance.
Due to the safe and conservative nature of floating rate bonds, investors should not expect high yields. FLOT comes with a 0.32% 30-day SEC yield. Nevertheless, Treasury money market funds are so starved for yield that anything with an extra basis point or two and the quality and liquidity of a Treasury security will provide an attractive alternative.
Looking ahead, the floating rate notes will generate more interest if Treasury prices fall and yields rise further, which should play out if the Fed continues to taper quantitative easing and hikes interest rates.