This article was originally published on ETFTrends.com.
The latest market sell-off that saw the Dow Jones Industrial Average lose over 1,300 points in two trading sessions caused investors to flee towards floating-rate bond ETFs and Treasury Inflation-Protected Securities (TIPS) as they dumped U.S. equities.
"The fight continues between bonds and stocks," said Joseph LaGrasta, ETF Sales & Trading at Virtu Financial. "Treasuries began the day down and equities were holding the line, but that soon changed as equity markets again started to rumble from yield worries. This spurred a flight to safety dumping money into treasuries. As yields started dropping the market turned back around only to have one more slide at end of the day. Today everything looks rosy again and Treasuries resume their fall."
Lagrasta noted that yesterday's sell-off saw mixed results with inflows into TIPS, cash and fixed-income ETFs that incorporated floating-rate notes.
"While fixed income ETF’s were busy, flow was quite mixed," said LaGrasta. "We saw some clients dipping into TIPs and a lot of folks buying floating rate note ETF’s and cash products."
Investors can look to ETFs with floating-rate debt issues, such as the SPDR Blmbg Barclays Inv Grd Flt Rt ETF (FLRN) , which 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.
“Floating rate notes with coupons that adjust to movements in LIBOR may be a more optimal solution to mitigate duration-induced price declines,” said Matthew Bartolini, Head of SPDR Americas Research. “Since 2003, in months where the US 2-year yield has increased, a floating rate note exposure has outperformed a fixed rate exposure with the same maturity band by an average of 0.25% to 0.07%. The floating rate note exposure also had positive returns in 90% of those months vs. 52% for fixed rate. Floating rate notes tethered to LIBOR can also provide income as yields sit north of 2.6% following LIBOR’s 132% increase since 2016.”
While floating rate bond ETFs provide the necessary hedge against a rising rate environment, rising inflation can tamp down any returns realized from floating rate corporate bonds. As such, investors are keen to supplement floating rate bond ETFs with inflation ETFs like the IQ Real Return ETF (CPI) as an option to hedge against inflation.
CPI seeks investment results that correspond to the IQ Real Return Index–a “fund of funds” that invests its net assets in the investments incorporated within the underlying index. Fixed-income investors using corporate bond ETFs are subject to duration risk tied to interest rates, but in an economic environment where inflation is also rising, an ETF like CPI would be of benefit.
“CPI is incorporated into portfolios specifically to provide a real return over inflation, without relying purely on duration,” Salvatore Bruno, Chief Investment Officer of IndexIQ, told ETF Trends. “Therefore, inflation is the primary driver of return and risk for the strategy. We see more conservative portions of the portfolio go to CPI compared to corporate bond or floating rate positions. We see cash being incorporated more into portfolios not for liquidity needs, but because investors do not find a suitable strategy that provides a real return over inflation without a significant reliance on duration.”
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