This year, advisors are contending with a fixed income conundrum. The war in Iran sent energy prices surging, reigniting inflationary pressures in the process. In theory, that should benefit Treasury Inflation-Protected Securities (TIPS), but that hasn’t been the case.
Actually, many of the basic ETFs in the TIPS category stumbled in the first quarter, as Treasury yields rose. In other words, TIPS and the related ETFs languished, as Treasuries belied their safe-haven reputation. Hence the conundrum. However, the good news is that advisors can navigate clients through this trying fixed income environment with floating rate notes. That asset class is accessible via ETFs such as the WisdomTree Floating Rate Treasury Fund (USFR ).
The $17 billion USFR, which turned 12 years old in February, is beating the Bloomberg U.S. Aggregate Bond Index on a year-to-date basis. Meanwhile, it delivers significantly less annualized volatility than that gauge and the largest TIPS ETFs. A deeper examination on USFR reveals why the ETF is a compelling idea in the current fixed income environment.
USFR: Shelter From the Storm
This year’s bond market action is a reminder that simply because inflation rises, TIPS don’t always perform as expected. Those bonds are vulnerable to rising Treasury yields.
“The interesting aspect to the UST market sell-off has come from the inflation-adjusted sector or TIPS. Once again, investors discovered that TIPS are not immune from increasing yields, even if the catalyst was arguably increasing inflation fears,” noted Kevin Flanagan, head of investment and fixed income strategy at WisdomTree. “Remember, TIPS are referenced to actual trailing CPI figures; they are not reset to a specific interest rate, like secured overnight financing rate (SOFR) or the three-month T-bill, to which Treasury Floating Rate Notes (FRNs) are tied.”
Read more: This Unique TIPS ETF Is Earning Its Stripes
Underscoring the case for floating rate notes (FRNs) and ETFs like USFR is the point that 10-year TIPS yields steadily climbed over the past decade. That period included some inflationary spikes, which may have drawn some market participants’ to TIPS. However, the rising yields meant investors endured lower prices on those bonds. FRNs were less vulnerable to that scenario, something for bond investors to keep in mind, as it appears the Federal Reserve may not reduce interest rates at all this year.
“The March jobs report underscored our position that the Fed is at, or near the end, of this rate cut cycle,” added Flanagan. “So, if the Fed is essentially done, or close to it, UST FRN yields are bottoming out. In addition, when the Middle East war does de-escalate, fixed coupon yields may come down from their high watermarks, but it could prove to be short-lived and volatility is not going away any time soon.”
USFR’s effective duration is just 0.02 years and its annual expense ratio is 0.15%.
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