This year’s introduction of the U.S. Treasury’s floating rate notes (FRNs), which may help investors limit interest rate risk without credit risk, are currently yielding, on average, approximately 0.10%, as of April 23, 20141.
For investors seeking the low interest rate sensitivity found with FRNs, but who may have a tolerance for investment-grade corporate credit risk, the floating rate notes found in Market Vectors Investment Grade Floating Rate ETF (FLTR) may offer an alternative option with a yield of about 0.80%, based on its underlying index, Market Vectors US Investment Grade Floating Rate Index2 (MVFLTR Index).
MVFLTR Index comprises corporate FRNs and is constructed with an allocation bias to notes slightly further out on the maturity curve. While its average years to maturity does not affect interest rate duration3 because of the FRN coupon-adjustment feature, it generally results in slightly higher credit spread duration4 than do other corporate floating rate note indices, which may also include government agency FRNs, as found with the Barclays US Floating Rate Notes (<5 Y) Index5.
FRN Index Performance
2/10/2011 – 3/31/2014
As a result, MVFLTR Index has provided higher total returns during stable or improving credit markets, since January 2012 for example, but also underperformed when credit spreads widened, as in times of economic stress seen in 2011.
For an investor with a constructive outlook on the economy and who may be expecting short-term interest rates torise as a result, FLTR may be an option to consider for higher relative yield compared to government and shorter-maturity FRNs.
Investment grade corporate floating rate notes are sometimes mistaken for floating rate bank loans, which are otherwise known as leveraged loans, and are collateralized, floating rate, sub-investment grade bank loans. Corporate floating rate notes are investment-grade securities that trade just like other corporate bonds and notes.
Each of these asset classes helps limit interest rate risk by paying a floating rate of interest, typically tied to a Libor6 rate, plus additional margin for credit risk.
Alternatively, the U.S. Treasury floating rate notes are sans credit risk, and are also available through recently launched exchange-traded funds (ETFs). However, investors seeking access to Treasury FRNs may have larger yield appetites than this instrument may be able to offer.
While Treasury FRN issues may provide a floating rate cash management alternative, investors with a tolerance for investment-grade credit risk may want to consider investment grade corporate FRNs accessible with the FLTR ETF, which has produced competitive yield and total returns since its inception.
Index returns assume the reinvestment of all income and do not reflect any management fees or brokerage expenses associated with Fund returns. Investors cannot invest directly in the Index. Returns for actual Fund investors may differ from what is shown because of differences in timing, the amount invested and fees and expenses.
1Source: Bloomberg
2Source: FactSet. Market Vectors Investment Grade Floating Rate Index (MVFLTR) consists of U.S. dollar-denominated floating rate notes issued by corporate issuers and rated investment grade by at least one of the three rating services: Moody’s, S&P or Fitch.
3Interest rate duration is a measure of bond price sensitivity to changes in interest rates.
4Credit spread duration is a measure of bond price sensitivity to changes in the difference in yield of a corporate bond over a comparable U.S. Treasury security.
5Barclays U.S. Dollar Floating Rate Note < 5 Years Index consists of debt instruments that pay a variable coupon rate, a majority of which are based on the 3-month LIBOR, with a fixed spread. The Index may include U.S. registered, dollar denominated bonds of non-U.S. corporations, governments and supranational entities.
6London Interbank Offer Rate (LIBOR) refers to the benchmark used by banks, securities houses and investors to gauge the cost of unsecured borrowing in the money markets for various periods of time and currencies.
Please note that the information herein represents the opinion of the portfolio manager and these opinions may change at any time and from time to time. Not intended to be a forecast of future events, a guarantee of future results or investment advice. Current market conditions may not continue. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. ©2014 Van Eck Global.
Fran Rodilosso is senior investment officer and a portfolio manager of theMarket Vector Investment Grade Floating Rate ETF (NYSE Arca: FLTR). Launched in April 2011, it was the first U.S. passively-managed ETF of its kind. FLTR seeks to replicate as closely as possible, before fees and expenses, the price and yield performance of the Market Vectors US Investment Grade Floating Rate Index (MVFLTR). The MVFLTR Index consists of U.S. dollar-denominated floating rate notes issued by corporate issuers and rated investment grade by at least one of the three rating services: Moody’s, S&P or Fitch.