Floating rate bonds and the related exchange traded funds could hold increased appeal for fixed income investors against the backdrop of rising interest rates.
The Federal Reserve has boosted borrowing costs twice this year and many bond market observers expect a third rate hike before the end of the year.
The iShares Floating Rate Bond ETF (NYSEArca: FLOT) is one of the largest ETFs dedicated to floating rate notes. 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 their short reset periods, these floating rate funds have relatively low rate risk.
“Floating rate securities pass on rate rises in the form of higher coupons, and alternatives for investors to manage rising rates have increased. It is critical to distinguish between different types of floating rate debt,” said BlackRock in a note out Thursday.
As a result of the safe and conservative nature of floating rate bonds, investors should not expect high yields. 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.
“The U.S. Treasury began issuing short-maturity floating rate notes in 2014 to diversify its cash funding needs. These bonds sport two-year fixed maturities and quarterly coupon resets. Short-term debt is not floating rate but can fit the bill by rolling over maturing debts at new yield levels. Indeed, short-duration bonds have posted positive returns even amid rising short-term U.S. rates,” according to BlackRock.
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FLOT, which is just over six years old, tracks the Bloomberg Barclays US Floating Rate Note < 5 Years Index. The $6.2 billion ETF holds nearly 550 bonds. FLOT has a 30-day SEC yield of 1.34% and an effective duration of 0.15 years. Duration measures a bond’s sensitivity to changes in interest rates.
Alternatives to FLOT include the iShares Treasury Floating Rate ETF (NYSEArca: TFLO), SPDR Barclays Investment Grade Floating Rate (NYSEArca: FLRN) and the Market Vectors Investment Grade Floating Rate (NYSEArca: FLTR).
For more on mixed income ETFs, visit our Fixed Income category.