Even though the Fed is considering lower rates, floating rate ETFs are useful

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Floating rate notes (FRNs) and associated exchange-traded funds received a lot of attention last year as the Federal Reserve hiked interest rates four times, but the asset class is still useful even with the Fed planning a rate cut or two this year.

Variable Rate Notes, as the name suggests, have a variable interest rate. Specifically, the Notes have a so-called reset period with interest rates linked to a benchmark index, such as Federal Funds, LIBOR, Prime Rate, or the US Treasury Bill rate. Due to their short reset periods, these floating rate funds present a relatively low rate risk.

Exchange-traded funds, including the IShares Floating Rate Bond ETF (CBOE: FLOT), provide access to the floats.

FLOT “seeks to track the investment results of an index composed of high quality floating rate bonds denominated in US dollars with remaining maturities of between one month and five years”, according to iShares.

“When rates go up, they offer higher coupon payments and their prices don’t go down as much as fixed rate bonds. In contrast, most funds in the Morningstar Ultra Short Bond category invest in fixed rate corporate and government bonds with less than three years to maturity, ”said Morningstar. in a friday note. “The fund effectively hedges against rising rates, but takes moderate credit risk and loses when rates fall.”

ETF FLOT review

The FLOT of $ 9.81 billion tracks the Bloomberg Barclays US Floating Rate Note

“Floating rate bonds are debt securities with variable interest payments,” according to Morningstar. “Their coupons usually adjust every three months to reflect changes in Libor. These instruments tend to perform well in a rising interest rate environment. In this environment, the fund’s coupons are adjusted upward, while the value of fixed rate bond funds tends to fall. On the other hand, when interest rates fall, the prices of fixed rate bonds gain and the coupons of variable rate bonds are adjusted downward. Even though both groups have a short duration, they behave differently.

The majority of FLOT’s holdings are rated A or BBB, with some in the AAA or AA range. Morningstar has a Bronze rating on the fund.

To learn more about the bond market, visit our Fixed Income channel.


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