While the Federal Reserve could be readying to lower interest rates later this year, the utility of floating rate notes (FRNs) and exchange traded funds, such as the WisdomTree Bloomberg Floating Rate Treasury Fund (NYSEArca: USFR) remain in place.
USFR, which debuted in February 2014, follows the Bloomberg U.S. Treasury Floating Rate Bond Index. The fund’s holdings are priced at a spread over 3-month Treasury bills. Floating rate notes featured in USFR mature in 2019 and 2020.
In the current environment, an idea to consider is pairing USFR with the WisdomTree Barclays U.S. Aggregate Bond Enhanced Yield Fund (NYSEArca: AGGY), which is unique compared to traditional aggregate bond funds.
The fund uses a“rules-based approach and re-weights the subcomponents of the Bloomberg Barclays U.S. Aggregate Bond Index to enhance yield, while broadly maintaining familiar risk characteristics. AGGY tries to boost return by reweighting the components of the Aggregate Index. But this additional yield is not free as it comes with greater credit risk and rate risk,” according to WisdomTree.
“We utilize Yield Enhanced (AEY) and U.S. Treasury floating rate (UST FRN) strategies and compare the results to the widely followed Bloomberg Barclays U.S. Aggregate Index (Agg) benchmark. At first, the combination centered around a 70% AEY and 30% UST FRN blend, but during 2019, this ratio has continued to be adjusted due to the decline in intermediate yields and the resulting flattening of the yield curve,” said WisdomTree in a recent research note.
Fun With Floaters
Floaters have some advantages of TIPS. Floating rate note coupon payments are based on a reference rate (90-day t-bills) plus a spread. Since 90-day bills are auctioned every week, the effective duration of floating rate notes is one week, which allows investors to capture higher rates of income as short-term rates rise. This also provides an opportunity for investors to boost income as the Federal Reserve hikes interest rates.
“The WisdomTree Yield Enhanced U.S. Aggregate Bond Fund (AGGY), which seeks to track the Bloomberg Barclays U.S. Aggregate Enhanced Yield Index, and the WisdomTree Floating Rate Treasury Fund (USFR), which seeks to track the Bloomberg U.S. Treasury Floating Rate Bond Index, can be utilized as the two ends of the barbell,” according to WisdomTree.
The pairing of AGGY and USFR could reward income investors at this juncture of the business cycle.
“The strategy laid out in this blog post offers a strategic solution designed to help fixed income investors navigate the waters that loom ahead without making a high conviction bet on where rates are headed in the seemingly ever-changing interest rate landscape,” according to WisdomTree.
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