Analyzing Floating Rate ETFs
Useful for navigating a rising rate environment?
January 2022. Reading Time: 10 Minutes. Author: Nicolas Rabener.
- Floating rate ETFs pursue differentiated strategies
- Some of them are highly correlated to equities, limiting any diversification benefits
- The correlation with interest rates and inflation has been low
Despite the consensus on high inflation being transitory in 2021, the five-year, five-year forward inflation expectation rate in the US remains stubbornly above 2%. Investors that hoped to be able to avoid the repositioning of their portfolios for higher inflation are forced to reconsider their asset allocation frameworks. High inflation tends to result in rising interest rates.
Last year, we analyzed inflation-themed ETFs and concluded that these were quite diverse in portfolio construction, but that the correlation to inflation has been relatively low. Then we analyzed ETFs that are marketed as instruments for a rising interest rate environment, where portfolios were similarly heterogeneous. Only ETFs with exposure to financial services companies and short bond positions offered a positive correlation to interest rates (read ETFs for Rising Interest Rates).
Investors concerned with high inflation or rising interest rates can also consider ETFs holding floating rate securities, which we analyze floating rate ETFs in this research note.
We focus on floating rate ETFs traded in the US, which is a universe of 18 instruments. The first fund was launched in 2017 and the increase in ETFs has been consistent across time with each year one or two more products coming to the market.
Floating rate instruments typically pay a base rate like LIBOR or SOFR plus a spread, so investors’ expectation is that there is minimal interest rate risk. These ETFs can be categorized into four types:
- Investment grade floating rate ETFs
- Collatorized loan obligation (CLO) ETFs
- Senior Loan ETFs
- Variable Rate Preferred ETFs
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