A number of factors may combine to increase investor interest in investment grade floating rate notes in the coming months, according to Fran Rodilosso, Fixed Income Portfolio Manager at Market Vectors ETFs.
“Investors seem to be looking for products that can serve as a viable supplement to cash or money market funds, with the latter currently providing virtually no yield,” said Rodilosso. “At the same time, they are also looking for protection against inflation and higher interest rates while worrying about the impact that the Federal Reserve’s ‘tapering’ of its quantitative easing program might have on lower-rated credit products.”
“Each of these concerns could potentially be addressed by investment grade floating rate note funds, which typically trade at a spread over 3-month LIBOR 1 ,” continued Rodilosso. “In a zero interest rate policy environment, that base rate remains quite low, currently at 0.27% 2 . Taking into account the spread that the investment grade borrowers pay over LIBOR, US-listed investment grade floating rate note exchange-traded funds today are yielding 3 between approximately 0.40% and 0.70%.”
“That type of yield is still better than that from money market funds, though with some degree of credit risk,” he added. “However, when short-term interest rates start to rise, the coupons on these notes will adjust, resetting quarterly, which means that the sensitivity of the price of floating rate notes to changes in short-term interest rates is extremely low, as their yield changes via the coupon adjustments rather than via a change in price.”Market Vectors offers one of the few floating rate note-focused exchange-traded funds (ETFs) in the marketplace with its Investment Grade Floating Rate ETF (NYSE Arca: FLTR), which differs from others in the market primarily in years to maturity, credit quality and yield potential. “FLTR’s added weighting to maturities beyond two years adds both yield potential and liquidity to the index,” said Rodilosso.