The Federal Reserve raised interest rates by 25 basis points on Wednesday, and some experts believe another six or seven rate hikes could be coming over the course of this year.
That could be a sign that it’s not too late for investors to consider some of the fixed income strategies that benefit from Fed tightening, including floating rate notes (FRNs). Multiple exchange traded funds provide exposure to “floaters” with one of the most venerable being the VanEck Vectors Investment Grade Floating Rate ETF (FLTR).
FLTR tracks the MVIS US Investment Grade Floating Rate Index, which is comprised of investment-grade floating rate debt. The $1 billion FLTR’s 214 holdings are corporate bonds, and the fund is showing the utility of FRNs in a rising rate environment as it’s topping broader bond strategies on a year-to-date basis.
“Indeed, FRNs have performed well year-to-date through February 28 in the face of rising rates, with returns that are approximately flat versus a -3.3% loss in the broad U.S. market (as measured by the ICE BofA US Broad Market Index) and -5.2% among fixed rate corporate bonds (as measured by the ICE BofA US Corporate Bond Index),” says William Sokol, VanEck senior ETF product manager.
When rates rise, it’s common for bond investors to seek lower duration options, and floaters more than check that box. Regarding FLTR, the VanEck ETF has an effective duration of just 0.03 years, according to issuer data. That means the Fed could go on a rate hiking bonanza, and FLTR won’t be as vulnerable as a fixed rate bond fund.
Investors shouldn’t overlook the potential benefits of FLTR holding corporate debt over government bonds, either.
“Even in the ultrashort, high quality segment of the market, however, there are ways to enhance income. For example, focusing on credit-oriented issuers like corporates, rather than sovereign and agency issuers, can increase the spread and, therefore, overall yield,” adds Sokol.
FLTR, which celebrates its 11th birthday next month, sports a 30-day SEC yield of 0.59%. That might seem low, but it’s actually appealing when considering the fund has essentially no interest rate risk. As for credit risk, that’s relatively benign in the fund, too, as over 62% of FLTR’s components are rated AA or A. Single issue risk is also low because none of FLTR’s holdings exceed a weight of 2.01%.
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The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.
