Profit from Rising Interest Rates with Floating-Rate Debt

Jim Woods

Jim Woods has over 20 years of experience in the markets from working as a stockbroker, financial journalist, and money manager.

Exchange-traded funds (ETFs) exist in even the most unlikely areas of finance, and floating-rate securities are no exception.

The largest ETF in this sector is the iShares Floating Rate Bond ETF (FLOT), which has more than $10 billion in assets under management and offers access to 700 floating-rate securities of investment-grade companies. Floating-rate securities are simply debt instruments that have a variable rate.

As such, they usually are tied to some kind of benchmark, such as the three-month London Inter-bank Offered Rate (LIBOR). These debt instruments gained some degree of notoriety during the “Taper Tantrum” of 2013, in which bond yields drastically increased after investors overreacted to the Federal Reserve tapering off quantitative easing. Floating-rate investments were perceived as a way to get around the short-term spike in yields.

In environments where interest rates are expected to rise, such as now, floating-rate securities tend to be more popular than fixed-income securities. Bond yields react inversely to interest rates, so market prices for fixed-income investments will drop when interest rates rise. Meanwhile, floating-rate investments, with no set price, are less affected. Also, many floating-rate investments offer price floors and ceilings that allow investors to know exactly how much a security will pay, making it a feasible income stream in times of rising and falling interest rates.

However, floating-rate investments tend to yield less as investors trade an enhanced income stream for greater safety, meaning reduced credit risk and volatility. That being said, FLOT’s 30-day SEC yield is 2.5%, which is still significantly above the yields of a good many ETFs.

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According to the ETF’s website, 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.” More than 50% of the portfolio exposure in the fund is dedicated to the banking sector, with consumer cyclicals, 8.2%, and supranationals, 7.8%, being the two next biggest areas.

Ever since the 10-year Treasury yield bottomed below 1.4% in July 2016, FLOT has outperformed the iShares Core US Aggregate Bond ETF (AGG), showing a slight gain compared to a loss of 5%. The fund trades with excellent liquidity of about 1.5 million shares per day, or about $78 million. The expense ratio is just 0.20%.

Chart courtesy of stockcharts.com.

FLOT’s holdings are made up of some of the strongest financial names. Top holdings include Goldman Sachs, 3.82%; Morgan Stanley, 3.80%; JPMorgan Chase & Co., 2.67%; Inter-American Development Bank, 2.60%; and Citigroup, 2.27%.

With the Federal Reserve rumored to be halting increases in the Fed Funds rate sometime later this year, investors may want to do research on current trends to avoid purchasing the iShares Floating Rate Bond ETF (FLOT) at a bad time.

I am happy to answer any of your questions about ETFs, so do not hesitate to send me an email. You just may see your question answered in a future ETF Talk.

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