Floating Rate Notes: A High Yielding Cash Complement
September 25, 2023
Read Time 4 MIN
The U.S. Federal Reserve’s (Fed’s) hawkish pause last week underscores that we remain in a “higher for longer” environment, and investors looking for yield and safety may continue to find attractive opportunities at the front-end of the yield curve. Although the policy rate was maintained at the most recent meeting, the Fed remains very focused on bringing inflation back to 2% and has proven that it is willing to keep monetary conditions tight as long as needed to achieve that objective. Amid a strong growth and employment outlook, Federal Open Market Committee (FOMC) members increased their predictions for where rates will be next year by 50 basis points. Although many investors have bet against what has been the most clearly telegraphed hiking cycle in memory, we continue to believe in the old mantra of “don’t fight the Fed,” and believe that investment grade floating rate notes may be an attractive option for investors in this environment.
Floating rate notes (FRNs) offer investors a coupon that is equal to a fixed spread over a short-term reference rate that adjusts each period. Because the coupon adjusts with prevailing interest rates, FRNs have near zero sensitivity to changes in interest rates, unlike fixed coupon bonds which decline in price as rates move up. In addition, the spread on corporate FRNs allow investors to earn additional yield above the risk free rate. With short-term rates expected to remain high and an increased likelihood of a “soft landing,” investment grade corporate FRNs may continue to offer an attractive combination of enhanced yields and safety versus other ultrashort options as well as longer duration fixed income.
Investment grade corporate FRNs, as measured by the MVIS US Investment Grade Floating Rate Index, currently provide a higher yield compared to T-bills and FRNs issued by the U.S. Treasury, longer duration Treasuries and investment grade corporates. Only non-investment grade fixed income, aside from CLOs, currently offers higher yields, but with substantially higher credit risk in addition to duration risk. To achieve similar yield levels within investment grade corporates, investors currently need to take substantial duration risk.
Yield vs. Duration
Source: ICE Data Services, JP Morgan and VanEck as of 9/19/23.
The lack of interest rate sensitivity means that investment grade FRNs strongly outperformed most fixed income over the past two years as rates have increased substantially. Their higher carry, due to the spread above the risk-free rate they provide, has resulted in significantly better returns versus 3-month T-Bills since March 2022 when the Fed began its current hiking cycle with over 100 basis points of outperformance through 8/31/2023. Although corporate FRNs do have price sensitivity to changes in credit spreads and can underperform in periods of credit stress, they still provided a higher risk adjusted return versus 3-month T-bills due to their higher yield. Further, the high carry provided by the asset class has provided insulation against more volatile periods in the credit market, as seen in their performance through the mini-banking crisis earlier this year.
| Trailing Returns | 3/31/2022 - 8/31/2023 | |||||||
| YTD | 1 Year | 3 Years | 5 Years | 10 Years | Return | Std Dev | Sharpe Ratio | |
| IG Corporate FRN | 5.14 | 6.41 | 2.31 | 2.52 | 2.21 | 4.32 | 2.00 | 0.22 |
| 3m Treasury | 3.13 | 4.25 | 1.55 | 1.66 | 1.07 | 3.22 | 0.54 | -3.78 |
| 10Y Treasury | -0.04 | -4.71 | -7.47 | -0.14 | 0.89 | -7.36 | 9.76 | -1.14 |
| 1-3Y US Corporate | 2.57 | 2.49 | -0.29 | 1.74 | 1.69 | 1.14 | 2.67 | -1.05 |
| 3-5Y US Corporate | 2.82 | 2.08 | -1.61 | 2.02 | 2.34 | -0.34 | 5.76 | -0.72 |
| US Corporate | 2.97 | 0.95 | -3.96 | 1.51 | 2.64 | -4.01 | 9.94 | -0.76 |
Source: Morningstar Direct, as of 8/31/2023. Past performance is no guarantee of future results.
The MVIS US Investment Grade Floating Rate Index is designed to provide a higher yield versus the broader FRN market by tilting the index to longer maturity bonds and by focusing on corporate bonds that offer a spread above the risk-free rate. In general, credit spreads are typically higher as maturity increases, allowing investors to benefit from a higher average spread without assuming any additional interest rate risk. This results in greater spread sensitivity versus floating rate Treasuries or agencies or shorter duration corporate FRNs. However, the sensitivity of the index to credit spreads is less than that of 1-5 year corporate bonds.
High interest rates may act to bring inflation down, but will also slow economic growth and potentially have a negative impact on riskier borrowers in particular. Default rates have already started rising among leveraged borrowers, and market expectations are for a continued increase (albeit from very low levels) as the lagged impact of rising rates continues to be felt. Investment grade FRNs allow investors to gain high quality floating rate exposure, minimizing default risk and potentially with lower volatility versus leveraged loans if spreads do widen substantially. For investors looking for the higher yielding ultrashort exposure that loans provide without direct exposure to potential defaults, we believe CLOs are another attractive option as they provide significantly greater spreads with built-in risk protections. Investment grade FRNs, on the other hand are a more conservative option and provide exposure to a completely different set of issuers. As a result, both can be suitable in a high-quality credit portfolio.
Investing in the Ultrashort Investment Grade space with VanEck
VanEck IG Floating Rate ETF offers exposure to investment grade corporate as it seeks to track the MVIS® US Investment Grade Floating Rate Index, which consists of U.S. dollar denominated floating rate notes issued by corporate issuers and rated investment grade that has a higher biased to longer maturity FRNs.
VanEck CLO ETF is an actively managed ETF, sub advised by PineBridge Investments, offering exposure to primarily investment grade-rated tranches of collateralized loan obligations (“CLOs”) of any maturity.
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Indices:
IG Corporate FRN: MVIS US Investment Grade Floating Rate Index tracks U.S. dollar denominated floating rate notes issued by corporate entities or similar commercial entities that are public reporting companies in the U.S. and rated investment grade.
US Treasury FRN: ICE BofA US Floating Rate Treasury Index tracks the performance of floating rate US dollar denominated sovereign debt publicly issued by the US government in its domestic market.
3m Treasury: ICE BofA US 3-Month Treasury Bill Index is comprised of a single issue purchased at the beginning of the month and held for a full month.
1Y Treasury: ICE BofA US 1-Year Treasury Bill Index is comprised of a single issue purchased at the beginning of the month and held for a full month.
5Y Treasury: ICE BofA Current 5-Year US Treasury Index is a one-security index comprised of the most recently issued 5-year US Treasury note.
10Y Treasury: ICE BofA Current 10-Year US Treasury Index is a one-security index comprised of the most recently issued 10-year US Treasury note.
30Y Treasury: ICE BofA Current 5-Year US Treasury Index is a one-security index comprised of the most recently issued 30-year US Treasury note.
US Corporate: ICE BofA US Corporate Index tracks the performance of US dollar denominated investment grade corporate debt publicly issued in the US domestic market
1-3Y US Corporate: ICE BofA 1-3 Year US Corporate Index x is a subset of ICE BofA US Corporate Index including all securities with a remaining term to final maturity less than 3 years.
3-5Y US Corporate: ICE BofA 3-5 Year US Corporate Index is a subset of ICE BofA US Corporate Index including all securities with a remaining term to final maturity greater than or equal to 3 years and less than 5 years.
1-5Y US Corporate: ICE BofA 1-5 Year US Corporate Index is a subset of ICE BofA US Corporate Index including all securities with a remaining term to final maturity less than 5 years.
10+ Y US Corporate: ICE BofA 10+ Year US Corporate is a subset of ICE BofA US Corporate Index including all securities with a remaining term to final maturity greater than or equal to 10 years.
US High Yield: ICE BofA US High Yield Index tracks the performance of US dollar denominated below investment grade corporate debt publicly issued in the US domestic market.
CLO: J.P. Morgan Collateralized Loan Obligation Index is the first rules-based total return benchmark for broadly-syndicated, arbitrage US CLO debt.
Leveraged Loans: J.P. Morgan Leveraged Loan Index is designed to mirror the investable universe of the USD institutional leveraged loan market.
Disclosures:
Please note that VanEck may offer investments products that invest in the asset class(es) or industries included in this blog.
This is not an offer to buy or sell, or a recommendation to buy or sell any of the securities, financial instruments or digital assets mentioned herein. The information presented does not involve the rendering of personalized investment, financial, legal, tax advice, or any call to action. Certain statements contained herein may constitute projections, forecasts and other forward-looking statements, which do not reflect actual results, are for illustrative purposes only, are valid as of the date of this communication, and are subject to change without notice. Actual future performance of any assets or industries mentioned are unknown. Information provided by third party sources are believed to be reliable and have not been independently verified for accuracy or completeness and cannot be guaranteed. VanEck does not guarantee the accuracy of third-party data. The information herein represents the opinion of the author(s), but not necessarily those of VanEck or its other employees.
An investment in VanEck IG Floating Rate ETF may be subject to risks which includes, among others, foreign securities, foreign currency, credit, interest rate, floating rate, floating rate LIBOR, restricted securities, financials sector, market, operational, sampling, index tracking, authorized participant concentration, no guarantee of active trading market, trading issues, passive management, fund shares trading, premium/discount and liquidity of fund shares, non-diversified, and index-related concentration risks, all of which may adversely affect the Fund.
An investment in VanEck CLO ETF may be subject to risks which include, but are not limited to, risks related to Collateralized Loan Obligations (CLO), debt securities, LIBOR Replacement, foreign currency, foreign securities, investment focus, newly-issued securities, extended settlement, affiliated fund investment, management and capital preservation, derivatives, cash transactions, market, Sub-Adviser, operational, authorized participant concentration, no guarantee of active trading market, trading issues, fund shares trading, premium/discount, liquidity of fund shares, non-diversified, and seed investor risks, all of which may adversely affect the Fund. Investments in debt securities may expose the Fund to other risks, such as risks related to liquidity, interest rate, floating rate obligations, credit, call, extension, high yield securities, income, valuation, privately-issued securities, covenant lite loans, default of the underlying asset and CLO manager risks, all of which may impact the Fund’s performance. Derivatives may involve certain costs and risks such as liquidity, interest rate, and the risk that a position could not be closed when most advantageous.
After-tax returns are calculated using the historical highest individual federal marginal income tax rates and do not reflect the impact of state and local taxes. Actual after tax returns depend on the investor's tax situation and may differ from those shown. The after-tax returns shown are not relevant to investors who hold their fund shares throughtax-deferred arrangements such as 401(k) plans or individual retirement.
The MVIS US Investment Grade Floating Rate Index is the exclusive property of MarketVector Indexes GmbH (a wholly owned subsidiary of Van Eck Securities Corporation), 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 IG Floating Rate ETF is not sponsored, endorsed, sold or promoted by MarketVector Indexes GmbH and MarketVector Indexes GmbH makes no representation regarding the advisability of investing in the Fund.
Index returns are not Fund returns and do not reflect any management fees or brokerage expenses. Certain indices may take into account withholding taxes. Investors cannot invest directly in the Index.
Shares of the Fund are not sponsored, endorsed, sold or promoted by MVIS. MVIS makes no representation or warranty, express or implied, to the owners of Shares of the Fund or any member of the public regarding the advisability of investing in securities generally or in the Shares of the Fund particularly or the ability of the Index to track the performance of its respective securities market. The Index is determined and composed by MVIS without regard to the Adviser or the Shares of the Fund. MVIS has no obligation to take the needs of the Adviser or the owners of Shares of the Fund into consideration in determining or composing the respective Index. MVIS is not responsible for and has not participated in the determination of the timing of, prices at, or quantities of the Shares of the Fund are to be converted into cash. MVIS has no obligation or liability in connection with the administration, marketing or trading of the Shares of the Fund.
MVIS DOES NOT GUARANTEE THE ACCURACY AND/OR THE COMPLETENESS OF THE INDEX OR ANY DATA INCLUDED THEREIN AND MVIS SHALL HAVE NO LIABILITY FOR ANY ERRORS, OMISSIONS, OR INTERRUPTIONS THEREIN. MVIS MAKES NO WARRANTY, EXPRESS OR IMPLIED, AS TO RESULTS TO BE OBTAINED BY THE ADVISER, OWNERS OF SHARES OF THE FUND OR ANY OTHER PERSON OR ENTITY FROM THE USE OF THE INDEX, OR THE FUND OR ANY DATA INCLUDED THEREIN. MVIS MAKES NO EXPRESS OR IMPLIED WARRANTIES, AND EXPRESSLY DISCLAIMS ALL WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE OR USE WITH RESPECT TO THE INDEX OR ANY DATA INCLUDED THEREIN. WITHOUT LIMITING ANY OF THE FOREGOING, IN NO EVENT SHALL MVIS HAVE ANY LIABILITY FOR ANY SPECIAL, PUNITIVE, INDIRECT, OR CONSEQUENTIAL DAMAGES (INCLUDING LOST PROFITS), EVEN IF NOTIFIED OF THE POSSIBILITY OF SUCH DAMAGES.
Index returns are not Fund returns and do not reflect any management fees or brokerage expenses. Certain indices may take into account withholding taxes. 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.
Investing involves substantial risk and high volatility, including possible loss of principal. Bonds and bond funds will decrease in value as interest rates rise. An investor should consider the investment objective, risks, charges and expenses of the Fund carefully before investing. To obtain a prospectus and summary prospectus, which contains this and other information, call 800.826.2333 or visit vaneck.com/etfs. Please read the prospectus and summary prospectus carefully before investing.
© Van Eck Securities Corporation, Distributor, a wholly owned subsidiary of Van Eck Associates Corporation.
666 Third Avenue | New York, NY 10017
Related Funds
Indices:
IG Corporate FRN: MVIS US Investment Grade Floating Rate Index tracks U.S. dollar denominated floating rate notes issued by corporate entities or similar commercial entities that are public reporting companies in the U.S. and rated investment grade.
US Treasury FRN: ICE BofA US Floating Rate Treasury Index tracks the performance of floating rate US dollar denominated sovereign debt publicly issued by the US government in its domestic market.
3m Treasury: ICE BofA US 3-Month Treasury Bill Index is comprised of a single issue purchased at the beginning of the month and held for a full month.
1Y Treasury: ICE BofA US 1-Year Treasury Bill Index is comprised of a single issue purchased at the beginning of the month and held for a full month.
5Y Treasury: ICE BofA Current 5-Year US Treasury Index is a one-security index comprised of the most recently issued 5-year US Treasury note.
10Y Treasury: ICE BofA Current 10-Year US Treasury Index is a one-security index comprised of the most recently issued 10-year US Treasury note.
30Y Treasury: ICE BofA Current 5-Year US Treasury Index is a one-security index comprised of the most recently issued 30-year US Treasury note.
US Corporate: ICE BofA US Corporate Index tracks the performance of US dollar denominated investment grade corporate debt publicly issued in the US domestic market
1-3Y US Corporate: ICE BofA 1-3 Year US Corporate Index x is a subset of ICE BofA US Corporate Index including all securities with a remaining term to final maturity less than 3 years.
3-5Y US Corporate: ICE BofA 3-5 Year US Corporate Index is a subset of ICE BofA US Corporate Index including all securities with a remaining term to final maturity greater than or equal to 3 years and less than 5 years.
1-5Y US Corporate: ICE BofA 1-5 Year US Corporate Index is a subset of ICE BofA US Corporate Index including all securities with a remaining term to final maturity less than 5 years.
10+ Y US Corporate: ICE BofA 10+ Year US Corporate is a subset of ICE BofA US Corporate Index including all securities with a remaining term to final maturity greater than or equal to 10 years.
US High Yield: ICE BofA US High Yield Index tracks the performance of US dollar denominated below investment grade corporate debt publicly issued in the US domestic market.
CLO: J.P. Morgan Collateralized Loan Obligation Index is the first rules-based total return benchmark for broadly-syndicated, arbitrage US CLO debt.
Leveraged Loans: J.P. Morgan Leveraged Loan Index is designed to mirror the investable universe of the USD institutional leveraged loan market.
Disclosures:
Please note that VanEck may offer investments products that invest in the asset class(es) or industries included in this blog.
This is not an offer to buy or sell, or a recommendation to buy or sell any of the securities, financial instruments or digital assets mentioned herein. The information presented does not involve the rendering of personalized investment, financial, legal, tax advice, or any call to action. Certain statements contained herein may constitute projections, forecasts and other forward-looking statements, which do not reflect actual results, are for illustrative purposes only, are valid as of the date of this communication, and are subject to change without notice. Actual future performance of any assets or industries mentioned are unknown. Information provided by third party sources are believed to be reliable and have not been independently verified for accuracy or completeness and cannot be guaranteed. VanEck does not guarantee the accuracy of third-party data. The information herein represents the opinion of the author(s), but not necessarily those of VanEck or its other employees.
An investment in VanEck IG Floating Rate ETF may be subject to risks which includes, among others, foreign securities, foreign currency, credit, interest rate, floating rate, floating rate LIBOR, restricted securities, financials sector, market, operational, sampling, index tracking, authorized participant concentration, no guarantee of active trading market, trading issues, passive management, fund shares trading, premium/discount and liquidity of fund shares, non-diversified, and index-related concentration risks, all of which may adversely affect the Fund.
An investment in VanEck CLO ETF may be subject to risks which include, but are not limited to, risks related to Collateralized Loan Obligations (CLO), debt securities, LIBOR Replacement, foreign currency, foreign securities, investment focus, newly-issued securities, extended settlement, affiliated fund investment, management and capital preservation, derivatives, cash transactions, market, Sub-Adviser, operational, authorized participant concentration, no guarantee of active trading market, trading issues, fund shares trading, premium/discount, liquidity of fund shares, non-diversified, and seed investor risks, all of which may adversely affect the Fund. Investments in debt securities may expose the Fund to other risks, such as risks related to liquidity, interest rate, floating rate obligations, credit, call, extension, high yield securities, income, valuation, privately-issued securities, covenant lite loans, default of the underlying asset and CLO manager risks, all of which may impact the Fund’s performance. Derivatives may involve certain costs and risks such as liquidity, interest rate, and the risk that a position could not be closed when most advantageous.
After-tax returns are calculated using the historical highest individual federal marginal income tax rates and do not reflect the impact of state and local taxes. Actual after tax returns depend on the investor's tax situation and may differ from those shown. The after-tax returns shown are not relevant to investors who hold their fund shares throughtax-deferred arrangements such as 401(k) plans or individual retirement.
The MVIS US Investment Grade Floating Rate Index is the exclusive property of MarketVector Indexes GmbH (a wholly owned subsidiary of Van Eck Securities Corporation), 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 IG Floating Rate ETF is not sponsored, endorsed, sold or promoted by MarketVector Indexes GmbH and MarketVector Indexes GmbH makes no representation regarding the advisability of investing in the Fund.
Index returns are not Fund returns and do not reflect any management fees or brokerage expenses. Certain indices may take into account withholding taxes. Investors cannot invest directly in the Index.
Shares of the Fund are not sponsored, endorsed, sold or promoted by MVIS. MVIS makes no representation or warranty, express or implied, to the owners of Shares of the Fund or any member of the public regarding the advisability of investing in securities generally or in the Shares of the Fund particularly or the ability of the Index to track the performance of its respective securities market. The Index is determined and composed by MVIS without regard to the Adviser or the Shares of the Fund. MVIS has no obligation to take the needs of the Adviser or the owners of Shares of the Fund into consideration in determining or composing the respective Index. MVIS is not responsible for and has not participated in the determination of the timing of, prices at, or quantities of the Shares of the Fund are to be converted into cash. MVIS has no obligation or liability in connection with the administration, marketing or trading of the Shares of the Fund.
MVIS DOES NOT GUARANTEE THE ACCURACY AND/OR THE COMPLETENESS OF THE INDEX OR ANY DATA INCLUDED THEREIN AND MVIS SHALL HAVE NO LIABILITY FOR ANY ERRORS, OMISSIONS, OR INTERRUPTIONS THEREIN. MVIS MAKES NO WARRANTY, EXPRESS OR IMPLIED, AS TO RESULTS TO BE OBTAINED BY THE ADVISER, OWNERS OF SHARES OF THE FUND OR ANY OTHER PERSON OR ENTITY FROM THE USE OF THE INDEX, OR THE FUND OR ANY DATA INCLUDED THEREIN. MVIS MAKES NO EXPRESS OR IMPLIED WARRANTIES, AND EXPRESSLY DISCLAIMS ALL WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE OR USE WITH RESPECT TO THE INDEX OR ANY DATA INCLUDED THEREIN. WITHOUT LIMITING ANY OF THE FOREGOING, IN NO EVENT SHALL MVIS HAVE ANY LIABILITY FOR ANY SPECIAL, PUNITIVE, INDIRECT, OR CONSEQUENTIAL DAMAGES (INCLUDING LOST PROFITS), EVEN IF NOTIFIED OF THE POSSIBILITY OF SUCH DAMAGES.
Index returns are not Fund returns and do not reflect any management fees or brokerage expenses. Certain indices may take into account withholding taxes. 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.
Investing involves substantial risk and high volatility, including possible loss of principal. Bonds and bond funds will decrease in value as interest rates rise. An investor should consider the investment objective, risks, charges and expenses of the Fund carefully before investing. To obtain a prospectus and summary prospectus, which contains this and other information, call 800.826.2333 or visit vaneck.com/etfs. Please read the prospectus and summary prospectus carefully before investing.
© Van Eck Securities Corporation, Distributor, a wholly owned subsidiary of Van Eck Associates Corporation.
666 Third Avenue | New York, NY 10017