As investors have piled into the relative security of Treasury bonds, many have been extremely disappointed with the near-record low payments that these safe securities have been yielding. This has pushed many into other types of bonds–such as corporate and municipals–that have seen large inflows as investors flee the increasingly uncertain stock market for the stability of semi-annual coupon payments.
In the beginning, investors had very few options when it came to investing in bonds, and most offered little in the way of diversification. However, the advent of ETFs offered investors many more options in-terms of diversification and liquidity, allowing options to obtain targeted exposure to slices of the bond market at a cheap and liquid level. Although these funds were a good start, there were many holes which remained unfilled for years, forcing investors to make do with the limited choices available [see our Closer Look At Total Bond Market ETFs].
Yet the bond ETF space has expanded rapidly in recent months, possibly in order to capitalize on this recent shift to fixed-income securities, with a variety of muni, Treasury, and corporate bond funds launching in recent months to provide investors with more options targeting different parts of the yield curve, credit quality levels, and maturity spectrum. Despite these rapid advances, one segment of the bond world remains relatively untapped: the floating rate side of the market.
Luckily for investors, this side of the market appears to finally be opening up thanks to a proposed fund from Market Vectors. According to a recent filing with the SEC, Market Vectors is planning to offer the Market Vectors Investment Grade Floating Rate Bond ETF under the symbol FLTR. The fund will track the Market Vectors Investment Grade Floating Rate Bond Index and will charge an affordable expense ratio of just 35 basis points [also see 2010: Year Of The Bond ETF].
The proposed fund would be comprised of U.S. dollar-denominated floating rate notes issued by corporate issuers and rated investment grade by at least one of three rating services: Moody’s Investors Service, Inc., Standard & Poor’s Rating Services, or Fitch, Inc. Investment grade securities are those rated Baa or higher by Moody’s or rated BBB or higher by S&P or Fitch. Recently, the underlying index consisted of 193 bonds.
The underlying index is market value weighted, adjusted so that the weight of all BBB issuers is the minimum of 40% or two times the number of securities with a BBB rating in the index. Any excess weight is distributed proportionally across the other bonds and the index is rebalanced on a monthly basis. The fund will also be one of the first to offer investments in callable securities, which could add to the overall risk profile of the fund by forcing the managers to reinvest the proceeds at lower rates. This issue could be an important one in the current environment; with rates near record lows, issuers will be tempted to reissue debt at lower rates [also read Convertible Bond ETFs: Best Of Both Worlds?].
Floating Rate Bonds In Focus
Rather than paying a fixed rate of interest, floating-rate securities offer interest payments that reset periodically, with rates tied to a certain interest rate index. Floating rate bonds were first introduced during a period of extreme interest rate volatility during the late 1970s and have remained popular ever since. Due to this structure, adjustable interest rates bonds fluctuate much less in response to market interest rate movements than do fixed rate bonds. However, there is a trade-off for investors; this reduction in interest rate sensitivity is met by a decrease in yield for investors. Yet, their yields are often comparable to short-term securities that are constantly rolled over from month-to-month and have the potential to allow investors to match asset and liability cash flows more effectively without worrying as much about interest rate changes [see High Yield Bond ETFs: Far Cry From AGG].
So, for investors who still have an itch for fixed income securities but are worried about the potential for higher rates crushing their bond prices, this new fund could make for an interesting choice should it pass through the SEC’s approval process and launch into the ever-increasing and diversified world of ETFs.
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Disclosure: No positions at time of writing.