It can be difficult to find a reliable source of investment income in today’s low rate environment. Could the VanEck Vectors Australian Floating Rate ETF (ASX: FLOT) solve that problem?
What Are ETFs?
Exchange-traded funds, or ETFs, are investment funds that are listed on a stock exchange and provide exposure to a range of shares or assets with one purchase.
This Rask Finance video explains ETFs:
VanEck Floating Rate ETF
The VanEck Vectors Floating Rate ETF invests in a portfolio of floating-rate bonds with the aim of tracking the Bloomberg AusBond Credit FRN 0+ Yr Index.
While many bonds have a fixed interest payment, floating-rate bonds pay an interest rate that is periodically reset to equal some sort of reference rate, such as the cash rate, plus a quoted margin.
This means that if interest rates were to rise, so too would the interest payments on the floating bond, while the fixed bond payments would remain the same. This makes floating bond prices less sensitive to interest rate changes so there is typically not much movement in the price.
The VanEck FLOT ETF is well-diversified, holding more than 200 floating rate bonds from Australian banks, foreign banks, other lending institutions and real estate investment trusts (REITs).
The vast majority of these bonds (more than 99%) have a maturity of fewer than five years, so most would be considered short-term bonds. Short-term bonds tend to offer lower interest rates and, because they are floating-rate bonds, the rates are tied to the current (low) interest rates.
So, you could guess that performance hasn’t been mind-blowing. Over the last 12 months, the FLOT ETF has returned 2.67%, and it has returned 2.62% per year since inception in July 2017. We’ve seen three interest rate cuts this year which boosts the price of fixed-rate bonds and provides capital gains, but for floating rate bonds it just reduces the interest paid.
The above returns include the effect of the 0.22% per year management fee.
Who Is This For?
With returns around 2.6%, you may wonder who this is for. Well, floating-rate bonds are considered to be very conservative investments because of their price stability, meaning your capital is relatively safe (compared to other asset classes).
The returns may be low, but a floating rate bond ETF could make sense as somewhere to hold excess cash. After all, no Australian bank account to my knowledge is offering a 2.6% interest rate. The FLOT ETF also pays dividends monthly for regular income.
Floating rate bonds may also make sense when interest rates rise because the bond coupons rise with the interest rates.
My Take
The VanEck Floating Rate ETF may not be for everyone, but it certainly has its benefits in terms of regular, stable income. Whether it’s a good purchase now or not may come down to where interest rates are heading. If interest rates begin to rise again, floating-rate bonds could be much better than fixed-rate bonds, but the opposite would be true for more interest rate cuts.
If this is all too confusing, our number one ETF pick is much easier to understand and offers an attractive dividend yield far higher than 2.6%. You can see what it is in the free report below.
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Disclosure: At the time of writing, Max does not have a financial interest in any of the companies mentioned.
