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Is Now The Time To Look At Floating Rate Bonds?

Summary Now that the Fed has begun raising rates, investors should refocus on risk minimization over yield maximization. Investors reaching for yield in securities like MLPs and high yield bonds have been hurt badly since the beginning of 2014. The iShares Floating Rate Bond ETF focuses on short term investment grade floating rate notes and carries an effective duration of just 0.14 years. In light of the Federal Reserve’s persistent zero interest rate policy, many investors have traveled further down the risk/return spectrum in order to improve yields on their portfolios. Anybody that’s dabbled in MLPs or high yield bonds over the past two years probably knows very well the risks that come with reaching for yields. The ALPS Alerian MLP ETF (NYSEARCA: AMLP ) is 40% off of its recent high while the high yield bond index is down over 20%. AMLP Total Return Price data by YCharts Now that the Federal Reserve has finally begun moving away from its zero interest rate policy and rates are slowly on their way back up, it might be time to focus more on principal preservation instead of yield maximization. Staying on the short end of the yield curve can certainly help accomplish that task but floating rate bonds should also be a consideration. The iShares Floating Rate Bond ETF (NYSEARCA: FLOT ) is the biggest floating rate note ETF out there at nearly $3.5B in assets. Its current yield of 0.5% won’t necessarily get income investors excited right now but its risk mitigation characteristics will once rates begin moving significantly higher. This ETF is benchmarked to the Barclays US Floating Rate Note

FLOT Vs. FLRN: The Best Floating Rate ETF

The Fed rate hike may be just around the corner and investors have started probing every possible safe option in a likely rising rate environment. A barrage of solid economic data, including a more-than-seven-year low unemployment rate in August, an improving service sector, decent consumer confidence, and a pretty strong housing market raised speculations over the first rate hike in more than nine years. Investors should note that while fixed income investing underperforms in a rising rate environment, there are several plays, even in the bond market, that could ward off rising rate worries. A floating rate instrument is such an option. Floating rate notes are investment grade bonds that 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 notes ideal for protecting investors against capital erosion in a rising rate environment. Below we highlight two popular floating rate bond ETFs and try to figure out which one is a better bet at the current level: iShares Floating Rate Note ETF (NYSEARCA: FLOT ) This is the most popular fund in the floating rate securities market space that follows the Barclays US Floating Rate Note < 5 Years Index. Holding 458 securities, the fund has an average life of 1.78 years and effective duration of 0.14 years. The product has amassed over $3.60 billion in its asset base while trades in volume of 650,000 shares per day on average. Sector-wise, the fund invests over half of its assets in banking followed by 8.4% weight in areas with no guarantee. Companies like JPMorgan (NYSE: JPM ) (4.12%), Goldman (NYSE: GS ) (4.07%) and Citigroup (NYSE: C ) (3.49%) are top three holdings of the fund. Bonds with 1-2 years of maturity have the highest exposure of 33.17% in the fund while bonds with 0-1 years take the second position with 28.69% weight. Expense ratio comes in at 0.20%. The fund is off 0.02% so far this year (as of September 11, 2015) and yields about 0.48%. SPDR Barclays Capital Investment Grade Floating Rate ETF (NYSEARCA: FLRN ) This ETF tracks the Barclays U.S. Dollar Floating Rate Note < 5 Years Index with average maturity of 1.73 years and modified duration of 0.12 years. It holds 445 securities and has been able to accumulate $387 million in its total asset base. The fund charges 15 bps in annual fees while volume is moderate at under 30,000 shares. Sector-wise, the product is tilted toward the financial sector with 61% exposure followed by the industrial sector (25.43%). Individual holding-wise, no stock holds more than 1.60% in the fund. Goldman gets the top priority followed by Kommunalbanken (0.97%) and Toronto-Dominion Bank (NYSE: TD ) (0.91%). Here also, bonds with 0-1 years and 1-2 years of maturity hold top positions with 30.88% and 36.21%, respectively. It has lost 0.3% in the year-to-date timeframe and has a dividend yield of 0.59% (as of September 11, 2015). Which One is the Better Bet? While both options are pretty intriguing in a rising rate environment and quite similar in nature, there's a subtle difference between the two that might give one ETF an edge over the other in a rising rate environment. The chart below details the two bond ETFs: FLOT FLRN Effective Maturity 1.78 years 1.73 years Effective Duration 0.14 years 0.12 years Default Risks Slightly higher FLRN Slightly lower than FLOT Interest Rate Risks Slightly higher FLRN Slightly lower than FLOT Concentration Risks Slightly High Slightly Low Expense Ratio 0.20% 0.15% Yield 0.48% 0.59% To sum up, both FLOT and FLRN both have high exposure in the better-performing financial sector. Both handle around 450 bonds and certain international exposure, but are dollar-denominated in nature. Yet, FLRN appears a less risky product compared with FLOT going by various risk matrixes. FLRN is cheaper too. Link to the original article on Zacks.com

5 ETF Strategies To Prepare For Higher Rates

With an improving economy and an accelerating job market, the prospect of interest rates hike is moving closer, despite global growth concerns. The Fed indicated its confidence in the economy in the latest FOMC meeting, and confirmed that it is on track to raise the interest rates for the first time since 2006, sometime later this year. In fact, Atlanta Fed President Dennis Lockhart yesterday stated that the interest rates hike could come as early as next month. This is especially true given that the first-quarter slump in the U.S. seems to have been tided over with 2.3% economic expansion in the second quarter. The economy created at least 200,000 jobs in 13 of the past 15 months, with broad-based gains and unemployment dropping to the seven-year low of 5.3%. Further, economic activity has been rising moderately, consumer confidence and spending has increased, and the housing market is seeing frenzied demand for homes. While the overall economy is gaining momentum lately, subdued inflation, lower business investments and soft exports continue to weigh on economic growth. As such, uncertainty still looms around the timing of interest rates. The Fed also indicated that the path of rate hikes would be gradual, meaning that the Fed will take baby steps once it embarks on the trail of increases. Given this, investors should be well prepared to protect themselves from higher rates, albeit at a slower pace. Here are a number of strategies that could prove extremely beneficial for ETF investors in the rising rate environment: The Financial Sector Remains a Hot Spot A rising interest rate scenario would be highly profitable for the financial sector. This is because the steepening yield curve would bolster profits for banks, insurance companies and discount brokerage firms. A broad way to play this trend is by using the Financial Select Sector SPDR Fund (NYSEARCA: XLF ), which has a Zacks ETF Rank of 1, or a ‘Strong Buy’ rating. Other top-ranked funds targeting the niche segment of the broad financial sector are the SPDR S&P Regional Banking ETF (NYSEARCA: KRE ), the SPDR S&P Bank ETF (NYSEARCA: KBE ) and the PowerShares KBW Capital Markets Portfolio ETF (NYSEARCA: KBWC ). These funds have a Zacks ETF Rank of 2, or a ‘Buy’ rating. Hedge with Niche Bond ETFs Though the fixed-income world is the worst hit by the rising rates scenario, a number of ETFs that employ some niche strategies, like the PowerShares Senior Loan ETF (NYSEARCA: BKLN ), the iShares Floating Rate Note ETF (NYSEARCA: FLOT ) and the iPath US Treasury Steepener ETN (NASDAQ: STPP ) could lead to huge gains. This is because the senior loan funds are floating rate instruments, and thus, pay a spread over the benchmark rate like LIBOR, which help in eliminating interest rate risk. On the other hand, floating-rate note ETFs pay 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, they are less sensitive to an increase in rates compared to traditional bonds. Further, the Steepener ETN directly capitalizes on rising interest rates. The note looks to follow the Barclays US Treasury 2Y/10Y Yield Curve Index, which delivers returns from the steepening of the yield curve through a notional rolling investment in U.S. Treasury note futures contracts. The fund takes a weighted long position in 2-year Treasury futures contracts and a weighted short position in 10-year Treasury futures contracts. Be Safe with Zero or Negative Duration Bonds Zero or negative duration bond ETFs provides exposure to traditional bonds, while at the same time short Treasury bonds using derivatives such as interest rate swaps, interest rate options and Treasury futures. The short position will diminish the fund’s actual long duration, resulting in a zero or negative duration. As a result, these bonds could act as a powerful hedge and a money enhancer in a rising rate environment. Currently, there are two zero duration and two negative duration bond ETFs from a single issuer – WisdomTree. The zero duration funds include the WisdomTree Barclays U.S. Aggregate Bond Zero Duration Fund (NASDAQ: AGZD ) and the WisdomTree BofA Merrill Lynch High Yield Bond Zero Duration Fund (NASDAQ: HYZD ), while negative duration fund include the WisdomTree Barclays U.S. Aggregate Bond Negative Duration Fund (NASDAQ: AGND ) and the WisdomTree BofA Merrill Lynch High Yield Bond Negative Duration Fund (NASDAQ: HYND ). AGND has duration of approximately negative 5 years, while HYND has negative 7 years duration. Beat the Market with ex-Rate Sensitive ETF Concerns over the rising interest rates are resulting in higher volatility in the market. In order to protect from both these issues, investors should consider the PowerShares S&P 500 ex-Rate Sensitive Low Volatility Portfolio (NYSEARCA: XRLV ). This fund provides exposure to 99 stocks of the S&P 500 that have both low volatility and low interest rate risk. It recently debuted in the space, and has gathered $63.9 million in its asset base within four months. Short Rate-Sensitive Sectors Investors worried about higher interest rates could also go short on rate-sensitive sectors like Utilities and Real Estate via ETFs. There are a number of inverse or leveraged inverse products currently available in the market that offer inverse (opposite) exposure to these sectors. While a leveraged play might be a risky option, inverse ETFs are interesting choices and provide hedging strategies in a rising rate environment. There are a handful of ETFs in this corner of the investing world. The ProShares UltraShort Utilities ETF (NYSEARCA: SDP ) is the only inverse ETF in the Utilities space employing a double-leveraged factor. In the Real Estate sector, there are three options – the ProShares Short Real Estate ETF (NYSEARCA: REK ), the ProShares UltraShort Real Estate ETF (NYSEARCA: SRS ) and the Direxion Daily Real Estate Bear 3x ETF (NYSEARCA: DRV ) – having leveraged factor of 1, 2 and 3, respectively. Original Post