AGG - TFLO: Now Is The Time Buy Rating

Summary

• TFLO is a solid choice for a rising-rate environment. It sticks to US Treasuries, avoiding "credit risk."
• This is a critical differentiator between the ETFs in this peer group that I like, and those I consider more risky.
• Short-term bond funds shouldn't be risky. But credit market conditions have, in the past, shown that they can be.
• That's why an ETF that captures the recent spike in yields has upside from continued rising rates and sticks to US Treasuries checks many boxes for me.
• TFLO gets a Buy rating, which is something I have not been handing out much lately. But the reward versus the risk of a major loss is compelling here.

By Rob Isbitts

Strategy

iShares Treasury Floating Rate Bond ETF ( TFLO ) is an ETF run by industry leader iShares. It invests in an interesting segment of the $24 Billion US Treasury market, Floating Rate Notes [FRN]. The US government first issued these in 2014, so they are a relatively new form of debt. TFLO allows investors to own US Treasuries with rates that "float" up or down, depending on bond market conditions.

Proprietary ETF Grades

• Offense/Defense:Defense

• Segment:Bonds

• Sub-Segment:Floating Rate

• Risk (vs. S&P 500):Very Low

Proprietary Technical Ratings

• Short-Term (next 3 months):Hold

• Long-Term (next 12 months):Hold

Holding Analysis

TFLO holds just 10 individual bond issues, with weightings of those holdings ranging from 3% up to 20% of assets. This might be a red flag for an equity fund, but these are US Treasury securities, so a large allocation to one bond is not something we are very concerned with. In fact, it makes this ETF more transparent. US Treasury Floating Rate Notes range in maturity up to 2 years, and this ETF is allocated about evenly between bonds maturing within 1 year and those maturing in between 1-2 years.

Strengths

There is a lot to like here, now that interest rates have risen from the floor (near zero for years). Investors get a short-term bond portfolio, all in Treasuries, so that's 2 risk-reduction factors right there. iShares is behind it, which helps from a stability standpoint. And, at over $4 Billion in AUM and an average trading volume of around $60mm, liquidity at the ETF level is solid. The ETF also pays monthly, so investors can get some level of immediate gratification when rates spike up, as they did in 2022. FRN's make up less than 3% of total US Treasury issuance, so this is a unique sliver of the giant US government bond market.

Weaknesses

The biggest weakness here is if interest rates dive down again. While that might help the total return of TFLO initially, we're talking about bonds maturing within 2 years. So there will not be much price appreciation. And, with the interest rate not locked in, the old problem of this ETF could make a comeback. TFLO's annual returns before the Fed's multiple rate hikes in 2022 was only around 1%.

Opportunities

I am not smart enough to predict the level of short-term interest rates. Frankly, few people are. While I will say that there are signs that rates could break either way (based of course on what the Fed decides during this year), holding this ETF does not commit an investor for the long-run. Thus, with rates elevated, there is a nice window of opportunity to benefit from where rates have gone, cash in on further rate hikes (or the market's anticipation of rate hikes), and still be able to drop TFLO like a bad habit if signs emerge that rates are going to quickly reverse course. All the while, this ETF represents a very low volatility endeavor.

Threats

The bond market is getting increasingly illiquid, so the main threat as I see it is that rates on these bonds get caught up in that, as rates are falling. That may be a farfetched scenario. But when we are positive on a security, and that ETF is investing in US Treasury securities, we have to stretch a bit to come up with a "threat." Sure, rates could plunge back toward zero. But that seems to us to be more of an opportunity cost than a threat.

Conclusions

ETF Quality Opinion

TFLO checks the boxes for us, as noted above. We have been following it for some time, years in fact. This is a good example of what we mean when we say we like an ETF, but need to find a good spot in the cycle to buy it.

As this chart shows, this was an ignored ETF and asset class, for good reason. It didn't pay much yield at all. No investment advisor would touch it because the yield was probably less than the advisory fee they charge their clients. But there's something about 5 quick rate hikes by the Fed that can make people rush in to a floating rate ETF. And, contrary to what Elvis once sang, we don't think that those rushing in are "fools."

ETF Investment Opinion

TFLO is a Buy. It could be the single best low-volatility way to stay in sync with rising rates. And if they fall a bit, there's still a decent return to be had here, we suspect.

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