The past few years have been difficult for bond investors. With interest rates still near historic lows and the Federal Reserve taking a cautious approach to rate hikes—particularly in the wake of this summer’s political and economic uncertainty in Europe—many bond investors are sitting on the sidelines yearning for the higher yields of yore.
Floating-rate corporate bonds, or “floaters,” can help investors position their portfolios for an eventual rate increase. Unlike traditional bonds, whose interest rates are fixed, floaters’ rates are based on a benchmark rate, such as the three-month LIBOR (London Interbank Offered Rate), plus a spread—which means if the benchmark rate goes up, so does the floater’s.
In the event of a rate increase (or in anticipation of one), investment-grade corporate floaters tend to reap the benefits more quickly than traditional bonds. That’s because most floaters make coupon payments quarterly (rather than the more-typical twice a year), plus short-term benchmark rates tend to move higher in anticipation of Fed rate hikes.
And if interest rates remain low, floaters can offer higher yields than cash or short-term Treasuries. They also have fairly stable prices.
Of course, the prospect of added reward typically comes with added risk, and floaters are no different. A floater’s spread tends to indicate its risk level: In general, the higher the spread, the lower the credit rating and the greater the risk of default. Because of this credit risk, floaters may also experience periods of price volatility if economic conditions deteriorate.
The market for investment-grade corporate floaters is small compared with the fixed-rate corporate bond market, although some exchange-traded funds (ETFs) that focus solely on floaters do exist. If you’re interested in floaters, consider working with a specialist who can help you navigate the market.