More Than Meets the Eye With Floating Rate Notes | ETF Trends

Broadly speaking, fixed income market observers believe the Fed will, at some point this year, lower interest rates. Perhaps even multiple times. Assuming the central bank makes good on that front, it can be inferred that the most rate-sensitive bonds will benefit. However, declining Treasury yields don’t necessarily diminish the case for less rate-sensitive bonds, including floating rate notes (FRNs).

In other words, exchange traded funds such as the WisdomTree Floating Rate Treasury Fund (USFR) still offer advantages for advisors and investors and those perks extend beyond simply hedging against rising rates.

USFR follows the Bloomberg U.S. Treasury Floating Rate Bond Index. The fund sports a distribution yield of 5.18%. And that’s impressive considering the ETF all but extinguishes rate risk. That’s confirmation the fund can act as a credible income-generating tool for investors.

USFR as a Tactical Idea

During the Fed’s most recent tightening regime, FRNs delivered on their hedging promise. For example, the $17.39 billion USFR gained 2% in 2022 as the Bloomberg US Aggregate Bond Index plunged 13%. Last year, the WisdomTree ETF rose 5.2% while delivering significantly less annualized volatility than the “agg” as the Fed hiked rates several times.

Currently, expectations are in place that the Fed won’t be hiking again. However, USFR is still modestly on a year-to-date basis. That could signal a tactical opportunity with the ETF.

Since last December, “the Agg has experienced a rather large amount of volatility as optimistic expectations for the timing and magnitude of potential rate cuts have undergone a visible transformation. It’s not that rate cuts have been ruled out, but rather the Fed, along with the labor market and inflation data, has not validated the broader market’s early enthusiasm,” noted Kevin Flanagan, head of fixed income at WisdomTree. “In fact, the money and bond markets’ current rate cut expectations have gone from six to about four decreases, or closer to what the Fed is projecting. Meanwhile, USFR has experienced a steady ascending trend and, as of this writing, has produced a positive total return of just under +1.0% versus a decline of a little over -1.0% for the Agg.”

Then there’s the aforementioned income proposition. As noted above, USFR sports a yield well over the agg. Flanagan details just how advantageous that is for investors.

“Another important point to consider is the yield differential between the two, where the average yield to maturity for USFR is 5.49%, or about 60 basis points (bps) above the Agg. In addition, the duration profile is strikingly different, as USFR possesses a one-week duration while the Agg’s is 6.25 years. In other words, the Treasury FRN strategy is offering visibly more yield without the added duration and elevated volatility of the Agg,” he concluded.

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