FLRN - FLRN: Floating Rate Investment Grade Bonds 6.06% Yield

2023-12-08 01:03:56 ET

Summary

• SPD Bloomberg Investment Grade Floating Rate ETF is a fixed-income ETF that holds floating rate investment grade bonds.
• The ETF offers a spread pick-up over treasuries with a 6.06% 30-day SEC yield.
• FLRN has exhibited a steady performance and a low duration, providing a total return of nearly 6% in 2023 with a modest -2.5% drawdown.
• The fund does contain credit risk via its collateral pool which exhibits maturities above one year. The fund mitigates this feature via a high grade collateral pool.

Thesis

The SPDR Bloomberg Investment Grade Floating Rate ETF ( FLRN ) is a fixed-income exchange-traded fund. The vehicle seeks to provide investment results that correspond to the price and yield performance of the Bloomberg U.S. Dollar Floating Rate Note < 5 Years Index. The ETF consists of a portfolio of high-grade corporate bonds that are floating rate, the majority of its holdings being based on 3-month SOFR with a fixed spread. Its composition and low duration have helped the ETF navigate in an exemplary manner the higher rates environment experienced in the past two years.

The fund falls in the cash parking vehicles sleeve and represents an attractive way to layer in a spread over short-dated treasuries, currently exhibiting a 6.06% 30-day SEC yield. Given its structure, the vehicle will reset lower once Fed Funds and implicitly SOFR move down, but it will have a slight lag given its 3-month SOFR fixing.

An investor in this name is picking up around 0.7% over risk-free rates, with a 0.03-year duration:

The pick-up in spread is attractive, with the fund having posted a total return close to 6% in 2023, versus 4.74% for the US Treasury 3 Month Bill ETF ( TBIL ).

We like this name until mid 2024 when the Fed is supposed to start cutting rates as per current market pricing and feel the vehicle offers an attractive risk adjusted return until said timing.

Analytics

• AUM: $2.4 billion.
• Sharpe Ratio: 0.22 (3Y).
• Std. Deviation: 1.04 (3Y).
• Yield: 6.06%.
• Premium/Discount to NAV: 0%.
• Z-Stat: n/a.
• Leverage Ratio: 0%.
• Effective Duration: 0.03 years
• Composition: Corporate Bonds

The FLRN performance has been steady

The fund has done what it is supposed to do, namely slowly accrete higher at prevailing yields:

As opposed to a pure treasuries fund, FLRN does have instances of drawdowns, mostly driven by credit spread widening on the back of a significant macro event. The vehicle had a -2.5 % drawdown in March on the back of the regional bank's crisis but quickly recovered to an accreting mode after its resolution.

This fund is not credit risk free because it contains corporate bonds with non trivial maturity dates, but it does a good job of mitigating that aspect via its composition:

Please note that only 9.16% of its collateral is 'BBB', with the rest in the 'A' category. Many short-term bond funds rely heavily on BBB names to extract additional basis points of yield, but FLRN manages its tenor profile via higher quality collateral.

Outside of a true systemic meltdown like Covid, do not expect drawdowns to exceed -2% for this name.

Collateral composition

The fund relies on highly rated corporate bonds to extract a higher spread from the market:

The vehicle is mostly composed of financials, followed by supra-nationals and industrials. As opposed to traditional short-term bond funds, this ETF has an extended maturity profile for its holdings:

The classic short-term bond fund contains fixed-rate corporate bonds with a maturity date in the next 12 months. Duration is managed via a short-term maturity profile. FLRN on the other hand contains floating rate collateral only, which makes maturity dates less meaningful from a duration standpoint. However, longer maturity dates do increase probabilities of default and sensitivities to credit spreads in case of systemic wide meltdowns like the one exhibited by Covid.

Floating rate has worked and will continue to do so

Floating rate assets have performed tremendously well in 2023, led by leveraged loans. Leveraged loans are high-yield floating rate assets, and find themselves on the opposite side of the spectrum when compared to FLRN from a creditworthiness perspective, but they tell the same story. 2023 has been a year of rising rates but compressing credit spreads outside of the March banking crisis. The results are tremendous, with net positive performances across the board. This trend will continue as long as the Fed does not start cutting rates.

Once the first cut occurs the market will start pricing in the path of future cuts and will look to migrate toward fixed-rate assets in order to lock-in yields. Currently, there is a divergence between what the market is pricing versus consensus economists' forecasts, but the opinion in the two camps is that the second half of 2024 will see with 100% certainty lower Fed Funds.

Risk factors for FLRN

The main risk factor for FLRN is a systemic meltdown led by financials. As we have seen during Covid FLRN can gap down if credit spreads widen out significantly as during Covid. Even if the fund has a very low duration, its longer tenor on the collateral ensures credit risk is present in the structure. Financials represent the main sector in the fund, thus a financials-driven crisis would be the worst-case scenario for the fund.

To put it into context, the March 2023 regional banks crisis only drew a -2.5% drawdown in the name, and we have seen regulators being uber-focused on providing liquidity and solutions to the banking system, as with the Bank Term Funding Program . Currently, U.S. banks are well-capitalized from a historical perspective, and the regulators have put in place programs to ensure bank runs are contained. We cannot rule out some further bankruptcies for small banks with poor loan loss provisions and deteriorating CRE exposures, but we do not think there will be a system-wide crisis that would prompt credit spreads to widen to Covid levels.

Conclusion

FLRN is a fixed-income ETF. The fund holds floating rate investment grade bonds and generates a 6.06% 30-day SEC yield. The vehicle falls in the cash parking funds category and offers a spread pick-up over treasuries. The fund does contain credit risk and exhibited a -2.5 % drawdown during the March regional banks crisis. With a floating rate collateral and 0.03 years duration, FLRN has posted a total return of nearly 6% this year and will continue to provide robust results until the Fed starts cutting rates. We are a buy here until mid-2024 for this name.

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