Floating rate notes (FRNs) and the related floating rate ETFs are receiving renewed attention this year as fixed income investors seek alternatives to traditional government bonds at a time when the Federal Reserve is increasing borrowing costs.
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.
Exchange traded funds, including the iShares Floating Rate Bond ETF (CBOE: FLOT), deliver access to floaters.
FLOT “seeks to track the investment results of an index composed of U.S. dollar-denominated, investment-grade floating rate bonds with remaining maturities between one month and five years,” according to iShares.
Floating Rate Facts for ‘FLOT’
FLOT, which is over seven years old, tracks the Bloomberg Barclays US Floating Rate Note < 5 Years Index and holds nearly 700 bonds. Floaters are designed to be less sensitive to interest rate changes, so FLOT’s effective duration is just 0.13 years.
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. FLOT’s 30-day SEC is 2.49%.
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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.
Floaters have been popular with investors this year. For its part, FLOT has seen year-to-date inflows of $3.78 billion, a total surpassed by just two other bond ETFs and seven ETFs overall.
FLOT charges 0.20% per year, or $20 on a $10,000 investment.
For more on the bond market, visit our Fixed Income Channel.