When A Free ETF Isn’t Cheap Enough

The floating-rate Treasury fund TFLO languishes despite an expense ratio of zero percent.

The U.S. Treasury issued a new type of security in January of this year: Treasury securities with floating rather than fixed rates. ETF issuers wasted little time doing what they do best—offering cheap, plain-vanilla exposure to it. The two ETFs here are the iShares Treasury Floating Rate Bond ETF (TFLO) and the WisdomTree Bloomberg Floating Rate Treasury Fund (USFR).

TFLO stands out in particular for a novel fee structure: It’s free. In a nod to the exceedingly low returns expected in this cashlike vehicle, the fund’s issuer, BlackRock, has waived the 15-basis-point fee through Feb. 28, 2015.

Still, investor interest in the ETF is modest, to be polite. TFLO only has $10 million in assets after more than seven months on the market. Slim as it is, that beats USFR’s $2.5 million in assets under management.

Floating-Rate Treasurys

To back up a step, floating-rate Treasurys are ultra-safe vehicles. As floating-rate instruments, they have miniscule interest-rate risk. And as products backed by the full faith and credit of Uncle Sam, their credit risk is quite low too.

The motivation for choosing them lies in the ability to capture any yield from rising rates in a safe and liquid product (more on liquidity in a moment).

All-In Costs

The word “free” is a bit misleading here too. ETFs cost money to trade, and investors expect, if not demand, liquidity in a cashlike vehicle. ETFs depend in part on strong trading volume for low-cost execution for smaller trades. For TFLO, however, investors are currently staying away in droves, undermining its liquidity.

Meanwhile, investors can access floating rate Treasurys directly, a method that eliminates commissions and trading costs.

The Waiting Game

The near-term outlook for meaningful investor interest in TFLO remains unclear. While the Fed signaled no imminent change to short-term rates on Sept. 17, the forecast for the federal-funds rate at the end of 2015 notched upward 25 basis points to 1.375 percent.

The forecast for the end of 2017 is an almost unimaginable 3.75 percent. That leaves TFLO in a holding pattern for now, but could make it much more useful someday.

Considering TFLO’s current investor lack of interest, the fund’s survival is not a sure thing given BlackRock’s demonstrated willingness to prune its suite of ETF offerings. However, I expect the fund to stick around.

BlackRock may not want to cede the space to a rival issuer, knowing that short-term rates will surely rise someday.

Whether TFLO will be “free” at that point is another question. The current fee waiver may expire just when the fund's utility is likely to increase, and the issuer has discretion over its extension. Still, if TFLO takes off, liquidity would improve and trading costs would come down, making it more attractive overall, even at 15 basis points.

Bottom line: ETF investors deem all-in costs for TFLO to be too high given current conditions—even with a zero expense ratio. The seemingly endless anticipation of rate increases continues; and a free-but-dormant ETF waits in the wings.

At the time this article was written, the author held no positions in the securities mentioned. Contact Paul Britt at [email protected] or follow him on Twitter @PaulBritt_ETF.