Investors looking for an alternative to traditional cash instruments can consider floating rate bonds and the related exchange traded funds. 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.
“Many investors are concerned about the effect of rising rates on bonds or stocks becoming overvalued after repeatedly hitting new highs. If you want to get your cash off the sidelines but aren’t ready to commit to something long term, consider a short-term bond exchange-traded fund (ETF),” said BlackRock in a recent note.
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.
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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 on its interest rate normalization schedule.
“The Fed has increased interest rates four times this market cycle and the current federal funds target rate is 1% to 1.25%, but inflation is trending around 2.2% using the consumer price index,” notes BlackRock. “Short-term market rates are moving closer to the inflation rate, but money market and cash yields have not kept pace.”
Rivals to FLOT include the iShares Treasury Floating Rate ETF (NYSEArca: TFLO), SPDR Barclays Investment Grade Floating Rate (NYSEArca: FLRN) and the VanEck Vectors Investment Grade Floating Rate (NYSEArca: FLTR).
For more on mixed income ETFs, visit our Fixed Income category.