The recent economic slowdown in the developed and emerging
nations has forced the domestic U.S. interest rates to plummet near
all time lows. A 'safe haven' sentiment among the market
participants and other investors has caused them to withdraw funds
from risky assets and park them in safer securities such as U.S.
Treasury bonds. Thanks to this, the 10 year Treasury bonds
currently yield around 1.60% while the long dated 30 year Treasury
bonds trade near 2.67% (read
Forget European Woes with These Three Country
Not only has this caused a downward pressure on the benchmark
rates, but it has also resulted in appreciation of the U.S. Dollar
(USD) against other major currencies. In order to strike a balance
between growth and inflation in these difficult times, the Federal
Open Market Committee (FOMC) has been pretty much following an
ultra-low interest rates policy, and looks to continue this for at
least this year (read
ETF Trading Report: 3-7 Year Bond, Small Caps In
This is best demonstrated by the recent extension of 'Operation
Twist' (in order to further decrease long term borrowing costs)
which looks to cycle short term bonds for longer dated ones.
Furthermore, in the FOMC's recent two-day meeting, sentiment
suggested that rates look to remain depressed into the future,
especially given how uncertain the current economic outlook is
around the globe.
Choices for income seeking investors
At a time like this, investors seeking current income
(especially bond investors) are left with very little choice to
play with. Due to the ultra-low yields, bond prices have
significantly appreciated. Therefore investing in bonds would
surely result in erosion of invested capital once interest rates
However, a variety of investment avenues, especially from the
ETF space, might be of particular interest to these investors.
Preferred stock ETFs offer a hybrid exposure for income
seeking investors and also scope for capital appreciation. Many
products from the preferred stock ETF space pay out attractive
yields and have performed well in the face of the weak economic
Complete Guide to Preferred Stock ETF Investing
iShares S&P U.S. Preferred Stock ETF (
pays out an annual yield of 6.02% and has returned 11.04% year till
date in terms of total returns. The
PowerShares Financial Preferred ETF (
has an impressive asset base of $1.64 billion and sports a yield of
6.93%. In terms of total returns the ETF has returned 13.95% year
Emerging markets generally have superior interest rates than
most developed nations. Therefore, for investors seeking
international diversification along with high levels of current
income, Emerging Market Dividend ETFs provide an excellent
opportunity. Moreover, the brief broad market slump last fiscal for
many of these nations have effected good valuations, thereby
offering substantial scope for capital appreciation (read
Top Three Emerging Market Dividend ETFs For Income
WisdomTree Emerging Markets Equity Income ETF (
pays out a solid yield of 4.49%.
SPDR S&P Emerging Markets Dividend (
also pays out an impressive 5.02% in annual yields. However, DEM
and EDIV have slumped 2.56% and 6.59% on year-to-date basis.
However another asset class that could provide a good
opportunity for income seeking investors that are looking to stay
in the bond world with minimal duration risk; floating rate bond
Floating Rate Bonds explained
Floating rate bonds (also known as floaters) are basically bonds
with variable coupons. These coupons are reset at a predetermined
date and are indexed to a particular benchmark rate. (i.e. London
Inter Bank Offer Rate or LIBOR or U.S 10 year Treasury Bond, etc.)
plus a variable premium. This variable portion of the coupon is
usually based on the credit rating of the issuer.
At the time of interest payment, the effective coupon would be
equal to, the benchmark/reference rate quoted at the previous
interest payment date
What sets these bonds apart from other plain vanilla debt
instruments is that a significant portion of the interest rate risk
is nullified by the change in coupons (i.e. variable coupon rate).
Therefore, holders of these instruments are protected from a
significant capital erosion resulting from an increase in general
Risks and Drawbacks
While these bonds usually go a long way in reducing interest
rate risk, they still are subject to credit risk of the issuer.
Therefore if the issuers go belly up, technically the bond holders
face the risk of losing all of their invested capital.
The coupons associated with these bonds are generally lower that
most traditional fixed income securities. Moreover, while these
bonds prevent against losses, the flip side also holds true-they
even restrict the upside. However, given the current economic
conditions and low interest rate scenario, investors could be much
better off playing the floating rate bond portfolio than the more
traditional bond segment.
iShares Floating Rate Note (
Launched in June 2011, FLOT is a floating rate bond ETF which
Barclays US Floating Rate Note
5 Years Index.
The index comprises of floating rate notes issued by various
institutions. The notes in the index are investment grade and have
a residual maturity ranging from a month, to five years.
The variable coupon for the notes in the index is equal to an
aggregate of 1/3/6 months LIBOR rate (i.e. reference rate) plus a
variable spread depending on the credit risk of the issuers. The
ETF has a weighted average maturity of 1.72 years and presently
holds 207 notes issued by various institutions. The ETF pays out a
yield of 1.17%.
Presently the 1/3/6 months USD LIBOR rates are 0.24525%,
0.46060%, and 0.73440%, respectively
read PIMCO Files For Three More Active Bond
As far as credit risk is concerned, the ETF can be considered a
relatively safe option for investors as the fund gets an overall
credit rating of A+ by S&P which means
Strong capacity to meet financial commitments, but somewhat
susceptible to adverse economic conditions and changes in
Also, an effective duration of 0.12 years signifies negligible
vulnerability to interest rate risks. The ETF charges a paltry 20
basis points in fees and expenses and has managed to witness an
impressive inflow in its asset base. It has total assets of $199.24
SPDR Barclays Capital Investment Grade Floating Rate ETF
The ETF seeks to replicate the performance of Barclays Capital
U.S. Dollar Floating Rate Note
5 Years Index.
The Index measures the performance of floating rate notes which are
U.S. dollar denominated and uses the 3 month LIBOR as the reference
rate. The ETF debuted in December of 2011 and since then has
managed to attract a moderate asset base of $9.10 million.
The ETF charges just 15 basis points in fees and expenses and,
on an average, 12,080 shares of FLRN are traded each day. The
weighted average maturity of the ETF is 1.42 years and currently it
is sporting a yield of 0.84%. An effective duration of 0.11 years
and 0.00% convexity suggests that the ETF is pretty much immune to
interest rate risk.
FLRN holds 102 securities presently and has a modest bid-ask
spread of 3.53%.
Market Vectors Investment Grade Floating Rate ETF
FLTR tracks the
Market Vectors Investment Grade Floating Rate Bond
which measures the performance of investment rate floating rate
bonds that are issued by U.S. firms as well as global corporates.
The product was launched in April 2011 and has total assets of
$7.27 million. The ETF lacks popularity as indicated by an average
daily volume of 1,848 shares.
FLTR has comparatively high weighted average maturity of 2.90
years and average modified duration of 2.75 years. Therefore it is
more sensitive to interest rate movements than most of its
counterparts. However, it charges a low expense ratio of 19 basis
points and has an average yield of 0.94% making it among the best
in the space for these two metrics.
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ISHARS-FL RT NT (FLOT): ETF Research Reports
SPDR-BC IG FR (FLRN): ETF Research Reports
MKT VEC-IG FRB (FLTR): ETF Research Reports
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