If there is one certainty with the Federal Reserve, it is that no one outside the central bank really knows exactly when the next interest rate hike is coming. Fed funds futures indicate diminishing chances of a rate hike at the Fed’s meeting later this month and, at most, bond traders are expecting just one rate hike this year.
In anticipation of a rising interest rate environment, fixed-income investors should consider exchange traded funds that track floating rate notes.
Should expectations of higher interest rates gain momentum, it would not be surprising to see investors embrace floating rate exchange traded funds as additions to fixed income portfolios.
The iShares Floating Rate Bond ETF (FLOT) is one of the largest ETFs dedicated to floating rate notes. Floating rate notes, like the name suggests, have a floating interest rate. Specifically, the notes’ have a so-called reset period with interest rates tied to a benchmark, such as the Fed funds, LIBOR, prime rate or U.S. Treasury bill rate. Due to their short reset periods, these floating rate funds have relatively low rate risk.
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FLOT “invests in fixed income securities whose interest payments adjust to reflect changes in the broader interest rate environment. The result is a portfolio whose overall duration is near zero and, therefore, protected from much of the downside risk that exists in a rising rate scenario,” according to a Seeking Alpha analysis of the ETF.
The rub with gaining protection from rising rates is a low yield. For example, FLOT yields less than 1%, which is below what investors can find on 10-year Treasuries. Looking ahead, the floating rate notes will generate more interest if Treasury prices fall and yields rise further, which should play out if the Fed continues on its interest rate normalization schedule.
“The low returns the fund has seen aren’t surprising given the low rate environment the fund has operated under. Those yields will rise as interest rates begin moving up but the low risk nature of the fund may be the more appealing aspect of this product,” adds Seeking Alpha.
iShares Floating Rate Bond ETF
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.