Even before the Federal Reserve hiked interest rates by 50 basis points last week and set the stage for more moves in the coming months, investors were looking to less rate-sensitive products.
In April, the WisdomTree Floating Rate Treasury Fund (USFR ) pulled in $1.1 billion of new money, including $167 million on the last trading day of the month. The cash haul is impressive as this fixed income ETF only manages $4.4 billion in assets.
Meanwhile, the iShares Floating Rate Bond ETF (FLOT ) and the SPDR Bloomberg Investment Grade Floating Rate ETF (FLRN ) pulled in approximately $400 million and $350 million, respectively, last month.
Demand for floating-rate ETFs should remain high, with the Fed poised to continue raising rates throughout 2022. Unlike ETFs that invest in fixed-rate bonds, funds focused on floating rate bonds are less sensitive to increases in rates because they pay a variable coupon rate based on the prevailing short-term market rates plus a fixed spread.
As a result of the quarterly coupon resets, the duration profile is historically and structurally low compared to the broader Aggregate bond index. Indeed, FLOT, FLRN, and USFR have an average duration of less than 0.1 years, significantly less than the 6.6 years for the iShares Core Aggregate Bond ETF (AGG ).
“This floating rate profile leads to a significantly more attractive yield-per-unit of duration versus other short-term exposures that could be considered to trim duration,“ wrote Matt Barolini, head of SPDR Americas Research, in his second quarter bond compass outlook.
FLOT and FLRN sport 30-day SEC yields of 0.78% and 0.73%, respectively, while USFR’s yield is 0.49%. Unlike USFR, which invests in relatively risk-free U.S. government securities, FLOT and FLRN invest in corporate bonds issued by investment-grade rated financial institutions such as Goldman Sachs and Morgan Stanley.
While senior loan ETFs, such as the SPDR Blackstone Senior Loan ETF (SRLN ) and the Invesco Senior Loan ETF (BKLN ), also benefit from floating rate attributes, these ETFs incur greater credit risk by owning loans from BB- and B- rated issuers.
Year-to-date through May 4, while AGG was down 9.1%, FLOT and FLRN were down less than 0.3%, and USFR was up 0.4%. For many advisors, fixed income ETFs are supposed to provide downside protection in client portfolios during times of uncertainty. These high-quality floating rate ETFs are doing that and then some.
“As the Fed hikes more, the yields on these bonds will increase,” noted Karen Veraa, Head of U.S. iShares Fixed Income Strategy at BlackRock. “Investors can use floating rate securities to shorten portfolio duration, put cash to work or as a tactical investment during a rising rate cycle.”
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