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This article was originally published on ETFTrends.com.
With fixed income investors looking for strategies that reduce duration risk, floating rate notes (FRNs) and the relevant ETFs are receiving renewed attention this year. That includes the iShares Floating Rate Bond ETF (CBOE: 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.
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.
“These bonds tie their coupon payments to the three-month London Interbank Offer Rate,” said Morningstar in a recent note. “So, when rates rise, they offer higher coupon payments and their prices don’t fall as much as fixed-rate bonds. In contrast, most funds in the ultrashort-bond Morningstar Category invest in fixed-rate corporate and government bonds with less than three years remaining until maturity. The fund effectively protects against rising rates, but it does take moderate credit risk and loses out when rates fall.”
FLOT, which recently turned seven years old and holds nearly 700 bonds, has $10.54 billion in assets under management. That makes it one of the largest floating ETFs on the market and it is growing. Year-to-date, investors have added $3.92 billion to the fund. Only two bond ETFs and eight ETFs overall have added more assets since the start of 2018. Still, FLOT is not perfect.
“Market-cap weighting skews the portfolio toward the largest debt issuers. In the floating-rate investment-grade corporate fixed-income market, there have been record debt issuances by U.S. financial institutions in recent years. The issuances were largely driven by low rates and postcrisis regulatory changes,” according to Morningstar.
Over 64% of FLOT's holdings are rated A or BBB. The fund has an effective duration of just 0.15 years, but the trade-off is with lower interest rate risk comes a lower yield. FLOT's 30-day SEC yield is just 2.50%.
“The fund’s five-year annualized return through May 2018 of 1.1% was better than 80% of its peers. This outperformance principally stems from its relatively aggressive credit profile. The fund, however, is likely to lag its peers during market downturns when credit spreads widen,” according to Morningstar.
Morningstar upgraded FLOT to Bronze from Neutral.
For more information on the fixed-income space, visit our bond ETFs category.
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