This year, the fixed income space is providing a significant jolt to the broader exchange-traded fund (ETF) universe in terms of inflows. In fact, bond ETFs are on a record pace of asset gathering even as the Federal Reserve has boosted interest rates twice this year. Bond investors that are skittish about additional rate hikes and the potentially erosive effects on fixed income portfolios have options to consider, including floating rate notes (FRNs). Also known as floaters, these bonds have variable, not fixed, interest rates. Floaters usually have interest rates tied to LIBOR, Treasury bills or related benchmarks.
The asset class is accessible via ETFs, including the iShares Floating Rate Bond ETF (FLOT). FLOT "seeks to track the investment results of an index composed of U.S. dollar-denominated, investment-grade floating rate bonds with remaining maturities between one month and five years," according to iShares. The ETF, which recently turned six years old, follows the Bloomberg Barclays US Floating Rate Note < 5 Years Index. (See also: FLOT: iShares Floating Rate Bond ETF.)
"Floating rate securities pass on rate rises in the form of higher coupons, and alternatives for investors to manage rising rates have increased," said BlackRock in a recent note. "It is critical to distinguish between different types of floating rate debt. The expanded menu of floating rate options today spans an array of income and risk."
The $6.2 billion FLOT holds 541 bonds, a significant portion of which are corporate bonds. In fact, eight of FLOT's top 10 holdings are courtesy of corporate issuers. Credit quality is not a concern with FLOT as over two-thirds of the ETF's roster is rated AA or A. In exchange for that reduced credit risk, FLOT investors endure a lower yield, as highlighted a 30-day SEC yield of just 1.34%. The upside, in addition to the lower credit risk, is reduced interest rate risk. FLOT's effective duration is just 0.16 years, according to issuer data. (See also: Managing Interest Rate Risk.)
"The U.S. Treasury began issuing short-maturity floating rate notes in 2014 to diversify its cash funding needs," according to BlackRock. "These bonds sport two-year fixed maturities and quarterly coupon resets. Short-term debt is not floating rate but can fit the bill by rolling over maturing debts at new yield levels. Indeed, short-duration bonds have posted positive returns even amid rising short-term U.S. rates."
Including FLOT, there are four dedicated floating rate ETFs on the market. The SPDR Bloomberg Barclays Investment Grade Floating Rate ETF (FLRN) has $1.27 billion in assets under management and is the second largest floating rate ETF behind FLOT. (See also: Another Idea for Rising Rates Protection.)