Treasury yields are all the rage right now, but with the Fed’s rate hikes continuing this week, getting the right exposure to Treasuries is important. As eyes turn towards short-duration Treasuries, it may be worth revisiting the ABCs of FRNs, or floating rate notes a unique flavor of Treasury offering available via the WisdomTree Floating Rate Treasury Fund (USFR) and its indexed approach to providing floating rate note yields.
Investors and advisors on the lookout for a way to play Treasury yields are increasingly looking at USFR, according to VettaFi’s advisor engagement data, with engagement for the ETF up 155% year over year (YoY). As inflation persists despite the Fed announcing yet another hike Wednesday, it remains a play popular with some advisors for the duration of the rising rate and inflation fight.
For more on inflation and FRNs: Hot Inflation Numbers? Eye Floating-Rate Treasuries
How do FRNs work, though? FRNs were introduced back in 2013 as the first new Treasury product since the Treasury Inflation-Protected Security (TIPS) in 1997. FRNs float, allowing their interest payments to change over time – rising as interest rates rise, and falling as interest rates fall.
Indexed to the most recent 13-week Treasury bill auction high rate, specific factors like the terms and conditions, as well as issue date and offering amount, are set before each auction, with initial auctions held for two-year FRNs in January, April, July, and October.
Functionally, an FRN is a bond, with many FRNs offering quarterly coupons that pay interest four times a year, though others pay monthly, semiannually, or annually. All that said, there is no guarantee the FRN rate will rise as fast as rates do overall in a rising rate environment like this, with so much dependent on the benchmark rate’s performance itself. That does mean that an investor holding an FRN still has some interest rate risk if the rate doesn’t keep up sufficiently.
In closing, FRNs tend to have less volatility and price valuations when rates rise as other fixed-rate bonds lose value, though due to the variable rates, coupon payments are sometimes unpredictable – advisors and investors would do well to check the maximum and minimum interest rates paid by each note, with some floating notes having caps and floors.
USFR presents a strong option when looking to get at floating rate note yields. Charging just 15 basis points, the strategy has returned 2% over the last six months according to YCharts, and may be a strategy to watch for FRN education and yields in the crucial weeks ahead for the inflation fight and ongoing uncertainty.
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