• ETFs

    Two ways to employ floating rate notes in your portfolio

    Brett Liddell, CFA
    29 August 2017
     

    There are two ways our Australian Floating Rate ETF (ASX code: FLOT) is being used in portfolios:

    1. As a substitute for cash to enhance yield

    • Cash held in savings accounts and term deposits is suffering from low interest rates while cash management trusts (CMTs) can carry relatively high management fees
    • FLOT offers access to a portfolio of floating rate notes (FRNs) that are expected to provide a higher yield than cash and short dated term deposits as their coupons are reset periodically at a margin above the 90-day bank bill swap rate (3mth BBSW)

    2. To reduce duration (interest rate) risk associated with fixed rate bonds

    • With FRNs, the coupon interest rate is a variable or ‘floating’ which means it tracks short-term interest rates

    Strategy 1: Enhancing cash yield

    FLOT tracks the Bloomberg AusBond Credit FRN 0+ Yr Index, the benchmark index of Australian FRNs.  Currently FLOT offers an attractive running yield, quoted at 2.66% as at August 14, 20171.

    FLOT serves as an effective substitute for, or in addition to:

    • Bank savings accounts

    • Term deposits

    • Cash managed accounts

    • Cash management trusts

    The table below summarises some of the pros and cons of each investment type.

    FLOT compare table

    According to the table below, FLOT offers a higher yield than the RBA Retail Deposit Rates.

    FLOT versus TDs

    The chart below highlights the outperformance of FRNs since the global financial crisis, with the return on cash measured by the Bloomberg AusBond Bank Bill Index.

    FLOT performance

    Strategy 2: Reduce duration risk 

    Investors can allocate part of their defensive bond allocation to FLOT.  The impact will be a reduction in duration risk.  That is, the sensitivity of the value of the bond to interest rate movements.

    Currently modified duration of the Australian benchmark for bonds, the Bloomberg AusBond Composite 0+ Years Index, is 4.96.  This means that with a 1% rate rise, the value of the bonds will fall 4.96%.  The modified duration of FLOT is only 0.15. 

    Blending FLOT with your current fixed income manager can reduce duration risk significantly.

    IMPORTANT NOTICE: This information is prepared by VanEck Investments Limited ABN 22 146 596 116 AFSL 416755 (‘VanEck’) as the responsible entity and issuer of VanEck Vectors® Australian Floating Rate ETF ARSN 619 241 851 (“the Fund”). Nothing in this content is a solicitation to buy or an offer to sell shares of any investment in any jurisdiction including where the offer or solicitation would be unlawful under the securities laws of such jurisdiction. This information is general in nature and not financial advice. It does not take into account any person’s individual objectives, financial situation or needs. Before making an investment decision investors should read the product disclosure statement and with the assistance of a financial adviser consider if it is appropriate for their circumstances. PDSs are available at www.vaneck.com.au or by calling 1300 68 38 37.  The Fund is subject to investment risk, including possible loss of capital invested. Past performance is not a reliable indicator of future performance. No member of the VanEck group of companies gives any guarantee or assurance as to the repayment of capital, the payment of income, the performance, or any particular rate of return from the Fund.

    Bloomberg Finance L.P. and its affiliates (collectively, “Bloomberg”) are not affiliated with VanEck and do not approve, endorse, review, or recommend the Fund. BLOOMBERG and the Bloomberg Ausbond Credit FRN 0+ Yr Index (“the Index”) are trademarks or service marks of Bloomberg licensed to VanEck. Bloomberg does not guarantee the timeliness, accurateness, or completeness of any data or information relating to the Index.

    VanEck® and VanEck Vectors® are trademarks of Van Eck Associates Corporation.