Exchange traded funds offering access to floating rate notes (FRNs), including the iShares Floating Rate Bond ETF (CBOE: FLOT), have been popular destinations for fixed income investors this year.
The $10.80 billion FLOT tracks the Bloomberg Barclays US Floating Rate Note < 5 Years Index and holds nearly 700 bonds. FLOT is just over seven years old and is the largest ETF dedicated to FRNs. The SPDR Blmbg Barclays Inv Grd Flt Rt ETF (NYSEArca: FLRN) is a rival to FLOT.
FLRN limits duration exposure with investments in debt securities with maturities that don’t exceed five years. In addition, at least 80% of its assets will be allocated towards securities comprising the index, such as U.S. dollar-denominated, investment grade floating rate notes. The floating rate allows investors to capitalize on any short-term interest rate adjustments in accordance with monetary policy.
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.
The Right Time for Floaters
The Federal Reserve has boosted interest rates twice this year and many bond market observers are expecting two more rate hikes, including one in September, before the end of 2018. That outlook is one of the reasons investors are flocking to FRN ETFs.
Year-to-date, FLRN and FLOT have seen inflows of $2.17 and $4.18 billion, respectively. FLRN rebalances on the last business day of each month.
Related: ETF Strategies to Navigate Rising Rate Conditions
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 charges 0.20% per year, or $20 on a $10,000 investment while FLRN’s annual expense ratio is 0.15%.
For more information on the fixed-income space, visit our bond ETFs category.