As fixed-income investors consider ways to hedge their portfolio against the negative effects of rising interest rates, consider a rules-based floating rate bond ETF to generate attractive yields without worrying about rate risks.
If fixed-income investors want to put their cash to work but are not ready to commit to long-term risks, some may consider a floating rate bond ETF, such as the VanEck Vectors Investment Grade Floating Rate (NYSEArca: FLTR) to act an alternative to traditional cash instruments. FLTR shows a 2.24% 30-day SEC yield and an effective duration of 0.10 years.
Ed Lopez, head of ETF product management at VanEck, argued that FLTR is not your typical floating rate bond ETF as it is constructed more like a smart beta strategy.
“FLTR has an index bias to longer maturity floating rate notes,” Lopez told ETF Trends in a call.
Related: Alternative Fixed-Income ETF Ideas for Rising Rates
The floating rate bond ETF’s portfolio includes 49.7% notes with a 3 to 5 year maturity, 25.7% with a 1 to 3 year maturity and 17.2% with a 5 to 7 year maturity. The portfolio shows an average maturity of 3.83 years.
“The ETF goes out longer on the yield curve, gets higher yields and still maintains short duration,” Lopez said.
FLTR provides exposure to notes that 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.
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. In a shifting interest rate environment, with the Federal Reserve eyeing a tighter monetary policy ahead, fixed-income ETF investors have to adapt to the changing market and look beyond the potential short-comings of traditional benchmarks like the Bloomberg Barclays U.S. Aggregate Bond Index, or so-called Agg.
Related: 4 Floating Rate ETFs for an Alternative to Cash
However, given FLTR’s tilt toward corporate debt, which includes a hefty 77.7% tilt toward the financial sector, the fund exposes investors to greater credit risks. The ETF’s portfolio includes a greater weight toward lower investment-grade debt, including 40.2% BBB, 45.3% A, 13.8% AA and 0.7% AAA.
Nevertheless, “if the economy continues to improve and rates go up at a controlled pace, I think credit risk is lower,” Lopez said.
For more information on the fixed-income markets, visit our Fixed Income Channel.