Concerns about higher rates send investors back to floating rate bonds.
With 10-year Treasury yields sliding, and longer-dated debt looking prospective again as the Federal Reserve signals that an interest rate hike isn’t as imminent as the market had originally expected, floating rate bond ETFs have been out of favor for much of this year. But now that tide seems to be turning.
The iShares Floating Rate Bond ETF (FLOT | B-99) and the competing SPDR Barclays Investment Grade Floating Rate ETF (FLRN | B-99)—which had been struggling to attract assets in the beginning of the year—have now raked in a combined $557 million in net new assets year-to-date, the bulk of which has come in recent weeks.
On Tuesday, FLOT was one of the most popular ETFs with investors, gathering upward of $137 million in one day. The $4.1 billion fund tracks a market-weighted index of U.S.-dollar-denominated, investment-grade floating-rate corporate bonds with maturities of zero to five years.
The 341-security portfolio, which has a duration of about 0.2 year for a 30-day yield of 0.3 percent, is a portfolio that offers a good play against duration risk. FLOT’s bonds pay variable coupon rates, meaning they are calculated as a spread over a benchmark, such as the three-month London interbank offered rate, according to our ETF screener. That feature minimizes interest rate risk, relative to fixed-rate bonds. FLRN works in a similar way.
The influx of assets into these ETFs could reflect increasing anxiety about the outlook for rates. Current 10-year Treasury yield levels would suggest the market is pricing in an interest rate hike sometime next summer, as the Federal Reserve adjusts its timetable in the face of an economy that’s growing more slowly than expected. Higher rates lead investors into shorter-dated and variable-rate instruments.
“Economic growth is a major determinant of inflation, which in turn influences interest rate,” Howard Lee, ETF.com fixed-income analyst, said. “It’s not surprising that these two funds struggled to gather assets at the beginning of the year when economic growth was hampered by severe weather.”
“Recent economic data points, however, mixed as they are, point to a stronger economy,” he added. “Higher interest is no longer a question of if, but when and how fast.”