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Protect Against Rising Rates with Floating Rate ETFs

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The three decade long bond bull market appears to be coming to an end as the Fed prepares to slow down its massive stimulus that kept the rates at artificially low levels in the past few years. While the statement issued after the FOMC meeting did not mention ‘tapering’, optimistic GDP and labor market forecasts for 2014 hinted that the committee members were getting more confident about the economic recovery.  But later during the press conference Bernanke stated that the Fed could begin ‘tapering’ later this year.

As a result of ‘taper talk’, interest rates had been going up in the past few weeks.  10 year treasury yield has risen to 2.64%, its highest level since August 2011. Bond investors have already lost a lot of money in the past few weeks and this trend may continue for some more time.

Investors worried about the increase in interest rates can consider investing in floating rate notes via ETFs. (Read: QE Tapering could make these bond ETF winners)

What are Floating Rate Notes?

A floating rate note is a bond with a coupon that is indexed to a benchmark interest rate. Some of the popular benchmarks include LIBOR and Treasury rates. Since the coupon is adjusted to reflect market interest rates, every one month, three months or six months, these bonds are much less sensitive to increases in rates compared with traditional bonds with fixed rate coupons, which lose value as rates go up. (Read: Spin-Off ETF continues to beat SPY)

iShares Floating Rate Note Fund (FLOT - Free Report)

Launched in June 2011, FLOT tracks the Barclays US Floating Rate Note less than 5 Years Index. The index comprises US dollar denominated investment grade floating rate notes with a remaining maturity of greater than one month and less than five years.

The variable coupon for the notes in the index is equal to an aggregate of 1/3/6 months LIBOR rate plus a fixed coupon spread depending on the credit risk of the issuers. (Read: Precious metal ETFs crumble in Fed meeting aftermath)

The fund currently holds 290 notes with a weighted average maturity of 1.8 years. The ETF charges a low 20 bps in annual fees from investors. The product has seen an impressive asset inflow this year, pushing its asset base to $1.9 billion. With just 17.1% if top ten holdings the fund is very well diversified, limiting the default risk of any individual issue.

SPDR Barclays Capital Investment Grade Floating Rate ETF (FLRN - Free Report)

FLRN tracks the Barclays Capital U.S. Dollar Floating Rate Note less than 5 Years Index. The Index consists of notes that pay a variable coupon based on 3-month LIBOR plus a fixed spread.

The ETF was launched in November 2011 and since then it has managed to attract assets worth $39.7million. The weighted average maturity and adjusted duration of the ETF are 1.7 years and 0.12 years, respectively.

The product currently holds 334 securities and charges just 15 basis points in annual fees. Further, it has a nice dividend yield of 1.28%, making it one of the best in the space in terms of yield.

Market Vectors Investment Grade Floating Rate ETF (FLTR - Free Report)

FLTR tracks the Market Vectors Investment Grade Floating Rate Bond Index which is comprised of US dollar denominated investment rate floating rate bonds that are issued corporate issuers.

Launched in April 2011, the product has attracted $27.4 million in AUM so far. It charges its investors 19 bps in annual fees.

The product currently has 71 holdings, with yield to maturity of 1.53 years and average modified duration of 3.00 years. The ETF currently has a yield of 0.91%.

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