Floating rate ETFs are kind of exchange traded funds that are targeted more towards senior loans which are also known as leveraged loans or floating rate loans. These are loans that are issued by an institution through a group of banks and institutional investors. The main difference between such loans and other non investment debt securities relate to the interest rate risk. Floating rate loans are generally floating rate debt which means that the applicable interest rate is calculated as a predetermined spread over a reference rate.
Many corporate debt securities pay a fixed coupon over term of the issue whereas the floating rate securities offer coupons that are pegged to a reference rate like a 3 month LIBOR over a spread. If the LIBOR is 1% the coupon rate on the debt will be 3% and if it jumped to 2% the coupon on the security will increase to 4% at the next reset rate. These are packaged bank loans with periodically resetting interest rates and the returns are driven by credit risk primarily. Read more
Powershares floating rate ETF plans
PowerShares laid out a plan for a floating rate ETF focusing on debt and has launched it earlier in the start of 2011. The Senior Loan Portfolio (BKLN) is the first ETF offering for credit market of low sensitivity to interest rate changes. This floating rate ETF interest rate risk is minimal because of the float feature but credit risk exists.
Investment Grade Floating Rate ETF (FLTR)
Van Eck, the leader in the ETF world and has focused on many innovative funds in the equities market. It has also launched the new Investment Grade Floating Rate ETF (FLTR) which tracks the Market Vectors Investment Grade Floating Rate Bond Index. This took place in less than two months of the BKLN debut.
This index comprises of US dollar denominated floating rate notes which are issued by corporate issuers and also rated by the investment grade of three rating services (S&P, Fitch or Moody’s). This floating rate ETF is presumed to appeal to the investors who want above average yield and are concerned about the inflation driven interest rates and Treasury bond values. Many institutions perceive it to be a lower risk ETF offering good liquidity. FLTR comes with an expense ratio of 0.49% with a maturity of about 2.75 years. The average coupon rate currently is at 0.93% however, the fund’s yields are expected to be lower.
The floating rate ETFs represent a low risk fixed income alternative which is presumed to perform well in the periods of rising interest rates. FLTR is the first ETF offering exposure to floating rate investment grade securities and it features minimal interest rate risk. Similarly the BKLN would not be significantly impacted by the interest rate hikes because an increase int eh interest rate will lead to a decline in the value of fixed rate debt.