Truly diversified Australian FRN exposure
Despite soaring electricity prices last week’s inflation numbers remain well below RBA’s target range of 2% to 3% dampening the markets expectation of near term rate rises. A month ago the market was pricing in rate rises by June next year, now there appears to be only a 50% chance of that occurring. While Floating Rate Notes (FRNs) offer a hedge in a rising rate environment, they also offer potential yields above cash and term deposits so are still useful in this environment.
RBA struggles with inflation projections
Last week, RBA Deputy Governor Guy Debelle, speaking in Sydney following the release of the latest inflation numbers, discussed the difficulty the bank has forecasting, stating: “… our central forecast will almost certainly be wrong.” If Australia’s central bank has difficulty predicting the economy, it’s no wonder investors do, so knowing where to invest isn’t easy. With cash rates at all-time lows, the easy option to park strategic cash in a term deposit is unlikely to be the best.
ETFs: Easy access to Floating Rate Notes (FRNs)
ETFs have made it possible for investors to hold a portfolio of bonds, enhancing the defensive part of their portfolio while receiving income and yields likely to be above term deposits, without the need to lock away their money for fixed terms. A portfolio of FRNs will have similar interest rate risk (duration) to cash and savvy investors are investing in FRNs ETFs to enhance their cash returns.
What are FRNs?
A FRN is a security that pays a coupon (interest) linked to a variable interest rate benchmark, such as BBSW. Unlike other bonds where income is fixed, the income of a FRN varies.
- Variable benchmark - in Australia most FRNs pay income set at a margin over the bank bill swap rate (BBSW). For example, the rate might be quoted as "3mth BBSW + 1%".
- Coupons are variable - rather than paying fixed coupons like traditional bonds, FRN coupons move in parallel with BBSW as the rates are reset periodically.
- Investment grade - FRNs are generally investment grade credit quality.
The chart below highlights yield premium FRNs offer over cash, as measured by the Bloomberg AusBond Bank Bill Index.
VanEck Vectors Australian Floating Rate ETF (ASX code: FLOT)
FLOT tracks the Australian FRN market benchmark, the Bloomberg AusBond Credit FRN 0+ Yr Index. To be included in the Index, a FRN issue must have a published investment grade credit rating from at least one of S&P, Moody's or Fitch; a minimum outstanding face value of $100 million and a minimum of 1 month to maturity. The index includes different sectors of the Australian economy beyond just financials.
FLOT offers investors five key benefits:
- Potentially attractive yield compared to term deposits and cash funds – Cash funds and term deposits are yielding very low returns, particularly after inflation. FLOT is designed to offer a higher yield in a tradeable and easy-to-access ETF avoiding low yielding cash and term deposit lock-ups.
- Short term, high quality credit – Conservative investors often invest in short-term bonds for exposure to investment grade credit. FLOT offers access to a portfolio of short-term investment grade floating rate bonds in a single trade on ASX.
- Monthly income – Dividends are paid monthly
- Protection against rising rates – FRNs pay coupons (interest) that move in parallel with short-term interest rates. This means coupon payments increase as interest rates rise (and vice versa) unlike fixed rate bonds which have fixed coupon payments.
- Professional management – FLOT is managed by VanEck, which was founded in 1955 and helps investors achieve greater diversification through global investing. As at 30 September 2017 we manage $53.4 billion, including over $15 billion in fixed income.
IMPORTANT NOTICE – FOR USE BY FINANCIAL SERVICES PROFESSIONALS ONLY
Issued 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 (ASX Code: FLOT) ('the Fund'). This is general information only 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 the Fund is appropriate for their circumstances. A copy of the PDS is available at vaneck.com.au or by calling 1300 68 38 37.
This information is believed to be accurate at the time of compilation but is subject to change. VanEck does not represent or warrant the quality, accuracy, reliability, timeliness or completeness of the information. To the extent permitted by law, VanEck does not accept any liability (whether arising in contract, tort, negligence or otherwise) for any error or omission in the information or for any loss or damage (whether direct, indirect, consequential or otherwise) suffered by any recipient of the information, acting in reliance on it.
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.
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 guarantees the repayment of capital, the payment of income, performance, or any particular rate of return from the Fund.