Should expectations of higher interest rates gain momentum, it would not be surprising to see investors embrace floating rate exchange traded funds as additions to fixed income portfolios. ETFs such as the iShares Floating Rate Bond ETF (NYSEArca: FLOT), SPDR Barclays Investment Grade Floating Rate (NYSEArca: FLRN) and the Market Vectors Investment Grade Floating Rate (NYSEArca: FLTR)have floating interest rates.
FLTR tracks the Market Vectors US Investment Grade Floating Rate Index (MVFLTR), which 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, according to Market Vectors.
The idea behind these ETFs is simple: Floating rate 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. [Fans of Floating Rate Notes]
Each of the aforementioned ETFs track investment-grade bonds with a floating rate component, which automatically adjust at periodic intervals in response to changes in the interest rates.
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.
“Another factor working in this ETF’s favor is its focus on credit quality. Floating rate notes can occasionally come from issuers with questionable credit profiles but this is entirely comprised of investment grade bonds. According to the fund’s fact sheet, the fund’s 14% allocation to BBB-rated notes is the riskiest investment this fund makes. The remaining assets are A-rated or better. Not surprisingly, over half of the fund is invested in notes issued by financial services firms. Banks would be expected to benefit from a rising rate environment since it allows them to generate more income from loans. A larger exposure to this sector should further enhance the quality of this ETF,” according to a Seeking Alpha analysis of floating rate bonds.
Market Vectors Investment Grade Floating Rate
