Bond investments hardly saw gains in 2013 thanks to taper concerns and growing worries over rising rates. However, things have taken a sudden turn in 2014.
With the Fed scaling back another round of monetary stimulus, equities lost some appeal as cautious investors started to seek more safety in their investments and flocked to fixed-income securities instead.
Amid such a backdrop, some specialized corners of the fixed-income space, like U.S. Treasuries, turned out to be solid performers. In fact, U.S. Treasury ETFs performed remarkably well as benchmark yields saw the largest monthly drop since August 2011.
Fund issuers are also keen to tap the opportunity as WisdomTree and iShares added new members to their fund family in the floating rate Treasury bond space on February 4.
The Treasury Department’s offering of about $15 billion in floating rate 2-year securities though an auction on January 29 basically spurred the need for launching such funds. This was the U.S. government’s first floating rate notes offering, as per media.
WisdomTree Bloomberg Floating Rate Treasury Fund, (USFR), in Focus
This passively managed ETF looks to track the Bloomberg U.S. Treasury Floating Rate Bond Index that follows the performance of floating rate public obligations of the U.S. Treasury. The Index is market capitalization weighted and is rebalanced monthly. The index consists of floating rate notes with two-year maturities.
USFR plans to charge 15 basis points in net annual fees– quite reasonable in the total bond market ETF space.
The floating coupon rates of the notes included in the Index are initially expected to be reset weekly according to the most recent 13-week T-bill auction, plus a spread, subject to a minimum net yield of zero percent.
iShares Treasury Floating Rate Bond ETF, (TFLO), in Focus
The new passively managed fund targets the Barclays U.S. Treasury Floating Rate Index. This is also a new market capitalization-weighted index initially consisting of the first-issued Treasury FRNs.
Index holdings are likely to increase with the quarterly issuance of Treasury FRNs that is underway. For this exposure, the fund will charge investors 15 basis points a year – same as USFR.
How might these fit in a portfolio?
Floating rate Treasury bonds are meant to provide investors shelter from interest rate risk and credit risk. At a time like this when investors are extremely cautious about rising rate risks and stock market volatility, investments in safer securities like U.S. Treasury bonds having significant protection against potential rising rate can be a good bet. And to accomplish this investing goal, USFR and TFLO come across as the best-suited products.
Actually, the market saw another $10 billion monthly cut in the U.S. monetary stimulus last week that has increased the risk of rising rates and upset the relatively risky stock markets. Investors afraid of an end to the cheap dollar era started to flee the equity space and build position in the U.S. Treasury floating rate bonds.
Though higher demand for government bonds is presently keeping the interest rates under control, or rather pushing the rates lower, we are not sure about how long this scenario will persist.
Floating rate bond normally has variable coupons indexed to a benchmark interest rate, such as LIBOR or Treasury rate, plus a fixed quoted spread. Due to their variable-coupon nature, these bonds are much less vulnerable to increases in rates as opposed to the traditional bonds with fixed rate coupons.
Also, since floating coupon rates adjust periodically, the value of floating rate bonds vary much less than fixed rate ones.
In case of U.S. treasuries, investors face much fewer credit risks as the issuer here is the U.S. Treasury. Quite expectedly, lower credit risks coupled with cushion against interest rate volatility will be sought by investors in the present taper-trodden environment.
Competition
There are ample choices both in the Treasury bond and floating rate corporate bond spaces, but hybrids of floating rate bonds and treasuries were non-existent in the ETF market so far.
In the Treasury bond space, options like iShares Barclays 1-3 Year Treasury Bond Fund (SHY), iShares Barclays 7-10 Year Treasury Bond ETF (IEF), iShares Barclays 20 Year Treasury Bond Fund (TLT) and iShares Barclays 3-7 Year Treasury Bond Fund (IEI) were prominent names in terms of assets.
On the other hand, in the floating rate category, there are a handful of options like iShares Floating Rate Note Fund (FLOT), SPDR Barclays Capital Investment Grade Floating Rate (FLRN) and Market Vectors Investment Grade Floating Rate ETF (FLTR) all with a focus on floating corporate bond funds. However, USFR and TFLO are likely to pose threats to each other.
The growing investor interest for floating treasury funds can also be felt from another filing from State Street Global Advisors. In fact, the latest note offering by the U.S. Treasury had also seen robust demand. Notably, the Treasury is slated for the second offering of two-year floating-rate notes on February 26.
Bottom Line
Given the discussed scenario, we expect the newly-launched funds not to face much difficulty in accumulating assets. Going forward, the products should have the first-mover advantage in the floating rate treasury space.
In today’s volatile market, what could be a better way to receive fixed income from safe-haven government securities along with reduced yield worries other than by tapping USFR and TFLO? The funds’ low expense ratio will also be a plus point in asset generation, so we are looking for big inflows for both of these funds, especially if interest rate risks creep back into the picture later this year.