JThe Federal Reserve raised interest rates by 25 basis points on Wednesday, and some experts believe six or seven more rate hikes could come this year.
This could be a sign that it’s not too late for investors to consider some of the fixed income strategies that are benefiting from Fed tightening, including floating rate notes (FRNs). Several exchange-traded funds offer exposure to “float”, 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 securities. FLTR’s 214 billion-dollar holdings are corporate bonds, and the fund shows the usefulness of FRNs in a rising rate environment as it dominates broader bond strategies year-to-date .
“Indeed, FRNs performed well year-to-date through Feb. 28 in the face of rising rates, with returns roughly flat compared to a loss of -3.3% across the board. US 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, Senior Product Manager ETFs at VanEck.
When rates rise, it’s common for bond investors to look for lower duration options, and floats tick more than that box. As for the FLTR, the VanEck ETF has an effective duration of only 0.03 years, according to data from the issuer. This means that the Fed could take advantage of a rate hike windfall and that the FLTR will not be as vulnerable as a fixed rate bond fund.
Investors should also not overlook the potential advantages of FLTR holding corporate debt over government bonds.
“Even in the ultra-short, high-quality segment of the market, however, there are ways to increase revenue. For example, focusing on credit-oriented issuers like corporates, rather than sovereigns and agencies, can increase the spread and, therefore, the overall return,” adds Sokol.
FLTR, which celebrates its 11and anniversary next month, sports a 30-day SEC yield of 0.59%. That might sound low, but it’s actually attractive considering the fund has virtually no interest rate risk. As for credit risk, it is also relatively benign in the fund, as more than 62% of FLTR’s constituents are rated AA or A. Single issue risk is also low as none of FLTR’s holdings exceed a weighting of 2.01%.
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