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Floating Rate ETFs Set to Surge on Rate Hike Bets

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After being dovish in the last few years, the Federal Reserve has hinted at the prospect of rising rates in two years. In the latest FOMC meeting, it has kept interest rates near zero but surprisingly raised the chances of two rate hikes by the end of 2023, sooner than the previously projected 2024, amid forecast for faster economic growth and inflation.

The central bank expects inflation to run hot this year to 3.4%, well above the goal of 2%, before receding to 2.1% in 2022. It also raised GDP growth from 6.5% to 7% for this year, the fastest calendar-year expansion since 1984. The unemployment rate remained unchanged at 4.5% as the labor market is still healing from the depths of the pandemic and has yet to recover 7 million jobs (read: Core Inflation at 29-Year High: 6 ETF Areas to Benefit).

Economic activity and employment have strengthened as rapid vaccination has reduced the spread of COVID-19 in the United States. Inflation has risen, and consumer confidence has picked up along with spending. In anticipation of this, interest rates have already moved up sharply in recent months. Now, the Fed’s hawkish view has resulted in a further rise in yields. The 10-year U.S. Treasury yields saw their biggest rise since early March while 2-year yields jumped to the highest level in a year following the Fed’s comment.

That said, investors seeking to prepare for higher rates could flock to the bonds with yields that track broader interest rates – floating rate bonds.

Why Floating Rate Bonds?

Floating rate bonds are investment grade and do not pay a fixed rate to investors but have variable coupon rates that are often tied to an underlying index (such as LIBOR) plus a variable spread depending on the credit risk of the issuers.

Since the coupons of these bonds are adjusted periodically, these are less sensitive to an increase in rates compared to traditional bonds. Unlike fixed coupon bonds, these do not lose value when the rates go up, making the bonds ideal for protecting investors against capital erosion in a rising rate environment.

Investors currently have four floating rate bonds ETF in the market, any of which could make for a compelling choice (see: all Investment Grade Corporate Bond ETFs here).

iShares Floating Rate Bond ETF (FLOT - Free Report)

This ETF follows the Bloomberg Barclays US Floating Rate Note < 5 Years Index and holds 447 securities in its basket. The fund has an average maturity of 1.45 years and an effective duration of 0.12 years. It focuses on better quality notes with 81% of them rated A or higher. The product has amassed $6.4 billion in its asset base while trades in volume of 847,000 shares per day on average. It charges 20 bps in annual fees (read: Fed Rate Hike in the Cards? ETFs to Buy).

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

This ETF tracks the Barclays U.S. Dollar Floating Rate Note < 5 Years Index with an average maturity of 1.70 years and adjusted duration of 0.12 years. It holds 434 securities with the top-rated bonds (A or higher) accounting for 82.5% share. The fund has AUM of $2.4 billion and charges 15 bps in annual fees. Volume is solid at around 452,000 shares a day on average.

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

This fund follows the Market Vectors Investment Grade Floating Rate Bond. Holding 240 securities, it has average years to maturity of 22.72 and modified duration of 0.11 years. The product has accumulated $608.4 million in its asset base and trades in an average daily volume of 213,000 shares. Expense ratio came in at 0.14%.

Invesco Variable Rate Investment Grade ETF (VRIG - Free Report)

Investors seeking an active approach could find VRIG an exciting pick. The fund seeks to invest at least 80% of its net assets in a portfolio of investment-grade, variable rate instruments that are U.S. dollar denominated and U.S. issued. It focuses on floating rate US Treasuries, government sponsored agency mortgage-backed securities, U.S. Agency debt, structured securities and floating rate investment grade corporate, holding 196 bonds in its basket. The ETF has amassed $480.7 million in its asset base and trades in an average daily volume of 132,000 shares. It charges 30 bps in annual fees.

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