In an environment of limited risk appetite and tightening monetary policy, there are few places to hide and even as fixed income comes back into play, interest rates threaten to submerge would-be bond investors. That is where ETF Stream’s ETF of the month – the $142m Lyxor $ Floating Rate Note UCITS ETF (SWIM) – comes in, allowing investors to ride the wave of hawkish policymakers.
With the Consumer Price Index (CPI) skyrocketing to 40-year highs, the Federal Reserve has been forced to tighten monetary policy quicker than market expectations, creating a challenging environment for traditional US Treasuries.
To avoid being caught by this rising tide, investors might consider allocating to floating rate bonds, which have variable coupon rates that are often tied to an index such as LIBOR in addition to a variable spread based on the credit risk of the issuers.
These bonds are ideally suited to a rate hiking backdrop as their coupons are adjusted periodically, meaning they do not lose value when rates rise. Lyxor’s SWIM is just one of several ETFs offering such an exposure in Europe.
Tracking the Bloomberg Barclays MSCI USD Corporate Liquid FRN 0-5 Year SRI Sustainable index, the product captures US dollar-denominated, investment-grade floating-rate notes issued by US and non-US corporates.
Constituents’ variable coupon is adjusted according to changes in the three-month USD LIBOR. In early May, the Federal Reserve implemented a 0.5% hike, its steepest funds rate bump since 2000.
Looking ahead, there is uncertainty over how far the US central bank’s tightening will go. With Fed chairman Jerome Powell saying in March the policymaker will work “expeditiously” to move inflation back to the 2% target, it is uncertain whether he and his counterparts will implement a single hike more dramatic than half a percent.
The CME FedWatch Tool, however, forecasts more than an 80% chance of the Fed Funds Rate reaching at least 2.75% by February next year.
Set against what some might consider a challenging backdrop at best, SWIM has returned 6.5% so far this year, as at 27 May and 11.8% over the trailing 12 months, according to data from ETF Logic.
Not only is this performance comfortably ahead of the flat returns booked by BlackRock’s $4bn US dollar-denominated floating rate product over the same periods, but SWIM also comfortably outperformed equivalent short-dated corporate bond ETFs – for instance the iShares $ Short Duration Corp Bond UCITS ETF (IGSD) – which booked gains of 3.2% and 7.8% over the two timeframes.
However, while SWIM has been a standout performer so far this year, some may not be surprised to hear Europe’s entire roster of floating-rate products have enjoyed healthy inflows so far in 2022. Indeed, BlackRock’s multi-billion dollar offering alone has seen over $760m inflows, as at 27 May.
Panning out to the longer-term view for investment-grade floating rate products, Nicolas Rabener, founder and CEO of FactorResearch, previously suggested such ETFs have historically offered “very low” returns alongside “minimal” risk since their arrival in 2007.
Bear in mind, these observations were carried out during a period of consistently low interest rates over the past decade. Should investors expect central banks to take a more hawkish stance in the coming years, floating-rate bonds may be the place to be.
This article first appeared in ETF Insider, ETF Stream's monthly ETF magazine for professional investors in Europe. To access the full issue, click here