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The 10-year U.S. Treasury rate is reaching fresh highs, and the Federal Reserve has a more hawkish outlook than in recent years. In this environment, floating rate notes (FRNs) may be an effective investment grade alternative to other fixed income instruments. They offer a conservative, investment grade income allocation that can complement cash holdings with meaningful yield pickup, as well as a near-zero interest rate duration option within a fixed income portfolio.
Securities linked to Libor1 or interbank rates have benefited investors more recently as interest rates have climbed. Floating rate notes are securities that employ coupon reset mechanisms, which help limit interest rate duration by fluctuating in line with base interest rates. These securities have also helped increase income, particularly as Libor has risen over 100 basis points since last year, mainly influenced by U.S. monetary policy.
Investment Grade Floating Rate Notes
Floating rate notes offer a conservative, investment grade income allocation that can be a complement to cash holdings with meaningful yield pickup, as well as a near-zero interest rate duration option within a fixed income portfolio.
Furthermore, greater yield potential can be generated by selecting corporate floating rate notes. In addition, allocating to longer-maturity floating rate notes has, historically, increased yield potential with only incrementally higher average return volatility.
It is important to note that a weightings bias toward longer-maturity floating rate notes, as seen with the MVIS Investment Grade Floating Rate Note Index, has had a negligible impact on interest rate risk given the notes’ coupon reset mechanisms. The table below compares recent returns, yields, and durations of comparable investment grade indices, illustrating the attractive risk/return trade off of floating rate notes.
Source: FactSet, Bloomberg. Data as of 4/30/2018 unless otherwise noted. Past performance is no guarantee of future results. All indices are unmanaged and are not securities in which investments can be made. Index returns are not representative of Fund returns. See Index Descriptions below.
Floating rate notes offer investment grade credit quality (i.e., BBB-rated and above), but with far less interest rate duration than traditional fixed income investments. Targeting corporate floating rate notes and longer average maturity notes may offer greater yield potential. Investors may use such an allocation to either enhance their cash positions or to meaningfully de-risk their portfolios from equity or below-investment grade credit exposures when market volatility becomes less favorable.
Investors can gain exposure to FRNs through VanEck Vectors® Investment Grade Floating Rate Note ETF (FLTR®).
1London Interbank Offer Rate (Libor) refers to the benchmark used by banks, securities houses and investors to gauge the cost of unsecured borrowing in the money markets for various periods of time and currencies.
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The information herein represents the opinion of the author(s), but not necessarily those of VanEck, and these opinions may change at any time and from time to time. Non-VanEck proprietary information contained herein has been obtained from sources believed to be reliable, but not guaranteed. Not intended to be a forecast of future events, a guarantee of future results or investment advice. Historical performance is not indicative of future results. Current data may differ from data quoted. Any graphs shown herein are for illustrative purposes only. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission of VanEck.
VanEck Vectors® Investment Grade Floating Rate ETF is not sponsored, issued or advised by Wells Fargo & Company, Wells Fargo Securities, LLC or any of their affiliates. The MVIS US Investment Grade Floating Rate Index is the exclusive property of MV Index Solutions GmbH (a wholly owned subsidiary of the Adviser), which has contracted with Wells Fargo to create and maintain and with Interactive Data Pricing and Reference Data, LLC to calculate the Index. Neither Wells Fargo nor Interactive Data Pricing and Reference Data, LLC guarantees the accuracy and/or completeness of the Index or of any data supplied by it or its agents or makes any warranty as to the results to be obtained from investing in the Fund or tracking the Index. The Index is calculated by Interactive Data Pricing and Reference, LLC, which is not an adviser for or fiduciary to the Fund, and, like Wells Fargo, is not responsible for any direct, indirect or consequential damages associated with indicative optimized portfolio values and/or indicative intraday values. The VanEck Vectors® Investment Grade Floating Rate ETF is not sponsored, endorsed, sold or promoted by MV Index Solutions GmbH and MV Index Solutions GmbH makes no representation regarding the advisability of investing in the Fund.
The indices listed are unmanaged indices and do not reflect the payment of transaction costs, advisory fees, or expenses that are associated with an investment in any underlying exchange traded funds. Index performance is not illustrative of fund performance. Fund performance current to the most recent month end is available by visiting vaneck.com. Indices are unmanaged and are not securities in which an investment can be made.
Index returns are not Fund returns and do not reflect any management fees or brokerage expenses. Investors cannot invest directly in the Index. Returns for actual Fund investors may differ from what is shown because of differences in timing, the amount invested and fees and expenses. Index returns assume that dividends have been reinvested.
MV FRN: MVIS US Investment Grade Floating Rate Index (MVFLTR) consists of U.S. dollar-denominated floating rate notes issued by corporate issuers and rated investment grade by at least one of the three rating services: Moody’s, S&P or Fitch. Bloomberg Barclays US Floating Rate Notes (<5 Y) Index consists of debt instruments that pay a variable coupon rate, a majority of which are based on the 3-month LIBOR, with a fixed spread, and may include U.S. registered, dollar denominated bonds of non-U.S. corporations, governments and supranational entities. Bloomberg Barclays Capital 1-3 Month Treasury Index is the 1-3 months component of the Short Treasury Index. The Barclays Capital Short Treasury Index includes aged U.S. Treasury bills, notes and bonds with a remaining maturity from 1 up to (but not including) 12 months. It excludes zero coupon strips. Bloomberg Barclays US Aggregate Bond Index is a broad-based benchmark that measures the investment grade, U.S. dollar-denominated, fixed-rate taxable bond market, including Treasuries, government-related and corporate securities, MBS, ABS, CMBS.
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