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.
Investors can access floating rate Treasuries via exchange traded funds, including the WisdomTree Bloomberg Floating Rate Treasury Fund (NYSEArca: USFR). The WisdomTree Bloomberg Floating Rate Treasury Fund tries to reflect the performance of the Bloomberg U.S. Treasury Floating Rate Bond Index, which is comprised of floating rate public obligations of the U.S. Treasury.
“In January 2014, the U.S. Treasury issued its first floating rate note (FRN). Treasury FRNs pay a coupon on a quarterly basis and mature in two years,” said WisdomTree. “The coupon rate ‘floats’ and is based on the 13-week t-bill yield plus a spread. The spread represents a snapshot of demand for a particular FRN when it is auctioned and remains fixed for the life of the note (low demand = high spread; high demand = low spread). The duration of the FRN is only one week because that is the amount of time between interest rate resets.”
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Expectations For Floaters
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 simple reason that we prefer floating rate notes versus rolling three-month t-bills over the next two years is that we want to receive higher yields as the Fed hikes rates,” said WisdomTree. “As short-term interest rates rise, the yield on Treasury floaters will reset each week at progressively higher rates. By contrast, if investors wanted to roll three-month t-bills over the next two years, they would only able to boost the yield of their holdings every three months (e.g., four times per year).”
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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.
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