State Street Plans Floating Rate Bond ETF

by on September 21, 2011 | ETFs Mentioned:

State Street has laid the groundwork for another addition to its lineup of fixed income ETFs, filing details with the SEC for a proposed product that looks to give investors another way to tap into an increasingly popular corner of the U.S. bond market. In the recent regulatory filing, the company detailed plans for the SPDR Barclays Capital Investment Grade Floating Rate ETF, which would seek to replicate the Barclays Capital U.S. Floating Rate Note < 5 Years Index. This ETF will track the price and yield performance of the market for U.S. dollar-denominated, investment grade, floating rate notes with maturities ranging from one month to no more than five years.

The fund will invest primarily in variable and floating rate securities, although it may also hold a portion of its assets in U.S. Treasuries. Additionally, the proposed offering may invest up to 20% of its assets in derivatives, including futures, options, and swap agreements; while it also reserves the right to invest in money-market funds and other short-term cash equivalents instruments on an ongoing basis to provide liquidity. International exposure is also an option seeing as the proposed ETF may invest in bonds of foreign corporations and governments so long as they are U.S. registered and dollar-denominated securities.

Investor’s appetite for inflation-fighting instruments has grown considerably and the appeal of floating rate debt has increased and for good reasons; considering that interest rates are bound to rise at some point in the foreseeable future, this corner of the bond market is better positioned than traditional fixed rate bonds, for the simple reason that floating rate securities can adapt to interest rate hikes far easier [see our Better-Than-AGG Total Bond Market ETFdb Portfolio].

This asset class can be attractive for investors looking to avoid interest rate risk because the effective coupon payments are reset on a regular basis and investors receive inflation-adjusted current returns [see Inflation-Proofing Q&A]. Floating rate debt will often increase the nominal yield along with inflation, meaning that investors can still achieve a real return. Investors holding fixed rate debt, on the other hand, may see a negative real return as the rate of inflation creeps up to overshadow the coupon payments on their debt [see Inflation ETF Special: 25 ETF Ideas To Fight Rising Prices].

Perhaps the most significant drawback of this segment of the fixed income market is the relatively low-yields offered when compared to more lucrative corners such as emerging market bonds or even foreign treasuries; the shield from undesirable ramifications following interest rate hikes, however, is a valuable quality that is hard to pass up.

Floating Rate Bond ETFs

State Street isn’t the first issuer to design a floating rate bond ETF; a number of competitors have already debuted products that focus on this corner of the market:

iShares Floating Rate Note Fund (FLOT): This fund gives investors access to the same index as the recently proposed State Street floating rate ETF. FLOT holds a well-balanced portfolio of just over 100 debt issues, with no more than 20% of assets going to the top ten holdings. The fund also allocates the majority of its holding in domestic bonds and notes, while exposure to foreign debt is also included and accounts for about one third of total holdings [see Using ETFs To Build A Complete Bond Portfolio].

Van Eck Market Vectors Investment Grade Floating Rate Bond ETF (FLTR): This fairly new offering tracks the Market Vectors Investment Grade Floating Rate Bond Index, which is comprised of U.S. dollar-denominated floating rate notes issued by corporate issuers and rated investment grade by at least one of the three major rating services. FLTR offers a much shallower portfolio of less than 50 debt holdings in total, and features a top-heavy portfolio, with the top ten components accounting for over half of all assets. This fund offers exposure to floating rate notes with maturities extending beyond five years and exposure is dominated by U.S. corporate bonds, although foreign debt receive a healthy allocation as well.

PowerShares Senior Loan Portfolio (BKLN): This is another new offering in the High Yield Bonds ETFdb Category and it is linked to the S&P/LSTA U.S. Leveraged Loan 100 Index, offering exposure to about 120 debt notes with a focus on riskier, higher-yielding securities. BKLN is designed to track the market-weighted performance of the largest institutional leveraged loans based on market weightings, spreads and interest payments. Investors should be aware that the majority of BKLN’s holdings are rated BB or lower and have a maturity of seven years or less.

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Disclosure: No positions at time of writing.