This article was originally published on ETFTrends.com.
Since 2016, the Federal Reserve has hiked rates seven times and if Goldman Sachs' forecast of five more rate hikes to come is correct, fixed-income investors might want to bring their flotation devices starting in December--not the apparatus that aids in keeping oneself above water, but fixed-income investments that feature a floating rate component.
“The Fed is unlikely to conclude the hiking cycle unless it is reassured that the labor market overshoot doesn’t grow much further,” said Goldman Sachs analysts Jan Hatzius, Alec Phillips and David Mericle, states. “Following the remarkable momentum in job growth, we update our estimate of the breakeven payroll pace that stabilizes the unemployment rate and estimate how long it will likely take before we get there.”
Rather than invest directly in the bonds themselves, investors can opt for exchange-trade funds that invest in debt issues that feature floating rate notes like the SPDR Blmbg Barclays Inv Grd Flt Rt ETF (FLRN) and the iShares Floating Rate Bond ETF (FLOT) . If the Federal Reserve remains hawkish on its rate-hiking stance, particularly with the latest economic data at its disposal, floating rates that move in conjunction with short-term adjustments will help protect a fixed income portfolio from rate risk.
FLRN seeks to provide investment results that correlate with the price and yield performance of the Bloomberg Barclays U.S. Dollar Floating Rate Note < 5 Years Index. FLRN limits duration exposure with investments in debt securities with maturities that don’t exceed five years. In addition, at least 80% of its assets will be allocated towards securities comprising the index, such as U.S. dollar-denominated, investment grade floating rate notes. The floating rate allows investors to capitalize on any short-term interest rate adjustments in accordance with monetary policy.
FLOT seeks to track the investment results of the Bloomberg Barclays US Floating Rate Note < 5 Years Index, which measures the performance of U.S. dollar-denominated, investment-grade floating rate notes. FLOT invests in the component securities of the underlying index and may invest up to 10% of its assets in certain futures, options and swap contracts, cash and cash equivalents, as well as in securities not included in the underlying index.
In a time when U.S. equities are experiencing heavy doses of volatility, especially after October's sell-offs, the case for bond allocation has become more compelling and with more rate hikes forecasted, it should signal to investors that bond ETFs with a floating rate component are worth a look.
"Given the Fed’s latest interest rate hike, interest rates have been moving up," said Maria Fenech, Investment Manager Support Officer at Calamatta Cuschieri. "Thus, portfolios that contain long-term asset allocations are now experiencing more volatility and hence, a reallocation should be considered."
For more trends in fixed income, visit the Rising Rates Channel.
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