Outside of cash instruments, there’s really no such thing as a risk-free bet in financial markets, but U.S. Treasuries are supposedly close. That is assuming interest rates don’t rise. That’s exactly what happened in 2022 and part of last year. And that decimated longer-dated U.S. government debt. Fortunately, there are avenues for adding safety to Treasuries. One of the better ideas is floating rate notes.
Colloquially known as “floaters,” these bonds are new relative to other forms of debt issued by Uncle Sam. They are accessible via ETFs such as the WisdomTree Floating Rate Treasury Fund (USFR).
One of the kings of the category, USFR did exactly what it was supposed to do when interest rates rose and proceed to remain elevated. Over the past three years, the fund gained 9.5% while the Bloomberg U.S. Aggregate Bond Index — a gauge heavy on traditional Treasuries — slid 9%. USFR has other benefits to offer fixed income investors as well.
Understanding USFR Perks
Not surprisingly, USFR was significantly less volatile on an annualized basis than aggregate bond ETFs or longer-dated Treasuries during the aforementioned tightening cycle. That wasn’t luck. It’s attributable to features inherent with floating rate notes.
“The volatility of the market price over the entire life of an FRN issue is typically only about two to six cents per $100 par amount,” according to a 2019 paper by Matthias Fleckenstein of the University of Delaware and UCLA Anderson’s Francis Longstaff. “(FRNs are) among the most-stable collateral or store-of-value options available in financial markets.”
Their research pertains to two-year floaters, which are included on the roster of the $17.64 billion USFR. As the academics note, floaters can be considered as safe as cash. But as USFR confirms, it’s possible to generate far more upside with this asset class than can be earned with money market accounts.
It’s also worth understanding how FRNs are able to deliver to investors significantly lower rate risk. Fortunately, that concept isn’t complex. It boils down to frequent resetting of the interest rates attached to these bonds.
“The notes have two-year terms. Each week during that term, the interest rate you earn is reset, based on yields at the Treasury’s weekly auction of 13-week T-bills. The T-bill yield closely tracks the Federal Reserve’s benchmark short-term rate, known as the federal funds rate. The FRN rate is the new T-bill yield plus a ‘spread’ set by the Treasury on each FRN issue at auction,” added UCLA Anderson School of Business.
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