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Bet on Floating Rate ETFs As Yields Surge

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The U.S. Treasury yields has been on the rise given the prospect of the Fed’s policy tightening as well as persistent high inflation. The 10-year yields topped the 1.6% level last week, its highest since Jun 4 while yields on 20- and 30-year bonds also jumped to levels previously seen in June.

The Fed has indicated that it will soon start rolling back on some of the monetary stimulus it provided during the pandemic crisis, primarily because inflation has met and exceeded the Fed’s 2% goal. The central bank is expected to begin scaling back the monthly bond purchases as soon as next month and complete the process by mid-2022. The policy statement also revealed that nine of 18 Fed policymakers Fed policymakers foresee a liftoff in interest rates next year compared to seven policymakers in June. The median dot also projects three to four total rate hikes by the end of 2023. Through the end of 2024, the median FOMC member sees six to seven total rate hikes (read: ETFs to Play Higher Benchmark Treasury Yields).

Meanwhile, inflation, which measures the increase in the cost of living over time, is running at 5.3% — the highest in nearly 13 years — driven by surging consumer demand, rising energy prices, and supply chain-related shortages. Additionally, the latest preferred inflation gauge by Fed rose 3.6% in August from the year-ago month, representing the biggest jump since 1991. This has fueled concerns that price increases will last longer than expected and eventually hit consumer spending. Additionally, a spike in commodity prices, especially energy, as well as the wider reach of COVID-19 vaccinations has lifted inflationary expectations.

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 bond ETFs 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 436 securities in its basket. The fund has an average maturity of 1.47 years and an effective duration of 0.09 years. It focuses on better quality notes with 83% of them rated A or higher. The product has amassed $6.8 billion in its asset base while trades in volume of 675,000 shares per day on average. It charges 20 bps in annual fees (read: Rising Yields Rattles Market: Inverse ETFs in Vogue).

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 1.77 years and adjusted duration of 0.06 years. It holds 431 securities with the top-rated bonds (A or higher) accounting for 85% share. The fund has AUM of $2.4 billion and charges 15 bps in annual fees. Volume is solid at around 379,000 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 222 securities, it has average years to maturity of 2.88 and modified duration of 0.03 years. The product has accumulated $729 million in its asset base and trades in an average daily volume of 217,000 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. This 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 holds 188 bonds in its basket and has amassed $455.7 million in its asset base. The ETF trades in an average daily volume of 90,000 shares and charges 30 bps in annual fees.