Pick No. 2: Fixed Income – Floaters, specifically the iShares Floating Rate Bond (FLOT | A-96)
Welcome to taper-land 2014!
While many pundits consider the micro-taper announced by the Federal Reserve to be a nonevent, it’s clear that easy money, eventually, is going away, and interest rates, eventually, are going to go up.
The big risks with bonds are always twofold: default (credit) and interest rate (duration).
A little-covered feature of the current bond market is that defaults are actually near historic lows. Moody’s speculative-grade (read: junk) default rate is currently tracking between 2.5 and 3 percent, which is well off historic averages and recent highs.
In other words, credit isn’t the big issue, and even if it were, default rates on investment-grade bonds are effectively zero, with minimal activity even in the B-grade credits and below. So that makes credit rather easy to predict and manage around.
So that leaves interest-rate risk. It’s a bit harder to predict interest-rate rises than it is to categorize default rates, but it seems clear to me there’s only one vector, and it’s northward. Luckily, near-zero duration, and thus interest-rate-insensitive, bonds aren’t that hard to come by. They’re called floaters.
There are two ways to play floating-rate bonds: investment grade and junk. I’m more inclined to think of the investment-grade products as viable core holdings, and my favorite in this area of the investment markets is the iShares Floating Rate Bond ETF (FLOT | A-96).
FLOT invests in the floating-rate debt of safe-as-houses corporate issuers, with a heavy tilt to financials.
Most of it is U.S.-based, but it does have exposure to other developed economies—again, mostly to banks, like Commonwealth in Australia or Royal Bank of Canada.
Short of a global financial catastrophe, I’m comfortable with the exposure here, and while the yield isn’t tremendous—about half a percent—it should scale nicely with any increase in interest rates.
Note: If you’re more inclined to look at the junky end of the spectrum, consider the PowerShares Senior Loan Portfolio (BKLN | B). It’s similar in approach, but takes on more risk—a lot more risk, down to credits rated in the C’s—to eke out a higher current yield, which is a lot higher, with BKLN’s current yield-to-maturity well above 5 percent.