By John Spence & Tom Lydon
Many investors worried about the prospect of rising interest rates are taking a second look at ETFs that invest in floating rate debt.
The Federal Reserve's bond buying and investors' desire for safety has pushed 10-year Treasury yields below 2%. However, bond investors could get hurt if interest rates finally start to rise after years of rock-bottom Treasury yields.
Floating rate notes are investment grade bonds that pay a floating rather than fixed rate coupon, which protects investors from rising interest rates.
ETFs in this category include Market Vectors Investment Grade Floating Rate Bond Fund (FLTR), SPDR Barclays Capital Investment Grade Floating Rate ETF (FLRN) and iShares Floating Rate Note Fund (FLOT).
Investors should keep in mind that floating rate note ETFs are currently paying little in the way of yield. For example, FLOT has a distribution yield of 0.71%, according to manager BlackRock.
Additionally, if rates stay low, these bonds could underperform their fixed-rate counterparts. Floating rate ETFs can also have heavy concentrations in the financial sector.
"Fixed-rate bonds have fared well so far in 2013, but a sudden jump in yields - as occurred in 1994 - would hammer pension funds and insurer portfolios, which have loaded up on fixed-rate debt in recent years," Reuters reported. "As a precaution, some fund managers worried about a sustained sell-off in the bond market have been replacing some of their pricey fixed-rate rate debt with floating-rate."
Separately, bank loan ETFs have also been popular with investors who are concerned about rising interest rates.
iShares Floating Rate Note Fund