XFLT - The Best Floating Rate Funds For Income Investors And Retirees

2023-10-30 12:35:17 ET

Summary

• Floating rate securities have strong yields, low duration, and have significantly outperformed YTD.
• There are several strong floating rate funds available to investors.
• Credit risk varies, but there are options with minimal risk and high yields in the floating rate space.
• A quick list of nine of these follows.

Floating rate securities currently offer investors a particularly strong set of benefits.

Yields are good, and higher than those of comparable fixed income securities, across credit ratings, asset classes, and maturities.

Interest rate risk is effectively zero, and dividends tend to see swift, strong growth when the Federal Reserve hikes rates. Dividend growth has been beyond outstanding since early 2022, due to Fed hikes.

Due to the above, returns have been very strong YTD, and would almost certainly remain strong if rates remain higher for longer . This is a distinct possibility, considering the fact that inflation remains above target, unemployment remains low, and recent Fed guidance .

Credit risk varies, but there are several options with minimal risk, and several with low risk and high yields.

Risk-return profiles are generally quite strong, especially for those securities and funds with below-average credit risk.

Due to the many benefits offered by floating rate securities, I've covered over a dozen floating rate funds in the past few months. For this article, I thought to write a very brief overview of some of these, to be used as a starting point for prospective investors, and for readers to have a broader idea of some of the opportunities in this sector.

A quick table with relevant information of nine different floating rate funds. Funds are ordered by dividend yield, which approximates risk. Due to recent dividend growth, I believe that SEC yields are a better gauge of expected future dividends than dividend yield.

In my opinion, the above funds are all buys.

The CLO ETFs have comparatively low credit risk and, in my opinion, the strongest overall risk-return profiles. Overall, the Janus Henderson B-BBB CLO ETF ( JBBB ) seems to be the best of these, with a strong, growing 8.6% SEC yield, and very low credit risk. Other funds might be better fits for more conservative investors, others for more yield-seeking ones.

Let's take a quick look at each of the funds above.

USFR - Floating Rate Treasuries

The WisdomTree Floating Rate Treasury ETF ( USFR ) invests in floating rate treasury notes. These securities behave similar to t-bills, with low interest rate risk and stable prices. Yields are marginally higher, as are returns.

Some of the increased dividends offered by USFR are eaten up by the fund's 0.15% expense ratio. Some investors might prefer to construct their own floating rate treasury portfolio, depending on the ease of doing so.

USFR is the safest, lowest-risk floating rate fund in its peer group. It seems like the best choice for the most conservative, risk-averse, short-term investors, and is a fantastic replacement for t-bills.

I last covered USFR here .

FLOT - Floating Rate Investment-Grade Bonds

The iShares Floating Rate Bond ETF ( FLOT ) invests in investment-grade bonds. These securities have a bit more credit risk and volatility than t-bills, although both remain quite low on an absolute basis. Yields and returns are a bit higher as well.

For investors looking for a bit more yield than t-bills or USFR, FLOT seems like an obvious choice.

FLOT currently yields around 1.0% more than investment-grade fixed-income securities and funds, as fund dividends have seen swift, strong growth following Fed hikes.

FLOT has significantly outperformed its fixed-income peers since early 2022, as the latter have a lot of interest rate risk, and Fed hikes have been very aggressive .

Investors looking for exposure to investment-grade securities, but concerned about higher rates, would do well to consider FLOT.

I last covered FLOT here .

JAAA - AAA-rated CLOs

The Janus Henderson AAA CLO ETF ( JAAA ) is an actively-managed ETF investing in AAA CLO tranches of senior secured loans. Simplifying things a bit, we can say that JAAA invests in bundles of corporate loans, and that the fund receives priority, senior payments from these.

Credit risk is effectively zero, as the fund's payments are prioritized. As per S&P , no AAA CLO has ever defaulted.

Portfolio volatility is a bit higher than expected, probably due to market perceptions of risk, and liquidity issues.

JAAA offers investors a 6.7% SEC yield, and effectively no interest rate or credit risk. Investors looking to minimize their risk will be hard-pressed to find a higher-yielding alternative to JAAA.

The fund does experience some volatility, so very short-term investors might prefer t-bills or USFR. JAAA's share price is still quite stable, however.

I last covered JAAA here .

JBBB - BBB-rated CLOs

The Janus Henderson B-BBB CLO ETF ((JBBB)) is an actively-managed ETF investing in BBB CLO tranches of senior secured loans. Simplifying things a bit, we can say that JBBB invests in bundles of corporate loans, and that the fund receives payments from these. Payments are in the middle of the pack in terms of seniority.

Credit risk is extremely low, as the fund's payments are senior enough. As per S&P, around 0.01% BBB-rated CLOs default each year. Defaults do increase during recessions, but the starting base is low enough that this rarely matters all that much.

As with JAAA, portfolio volatility is a bit higher than expected, but still much lower than that of bonds, both investment-grade and high-yield.

JBBB offers investors an 8.6% SEC yield, effectively no rate risk, and very low credit risk. In my opinion, this is an incredibly strong value proposition, and the strongest overall risk-return profile in its peer group.

The fund experiences moderate volatility, so short-term investors might prefer other funds. This is a much more important issue for JBBB than for JAAA.

I last covered JBBB here .

FLBL - Senior Loans

The Franklin Senior Loan ETF ( FLBL ) invests in senior loans. These securities are senior to other loans and bonds, secured by company assets, and generally incurred by riskier, non-investment grade companies.

Credit risk and default rates are both high, and tend to spike during recessions. Expect sizable losses during these.

Due to their high credit risk and recent Fed hikes, senior loans currently yield a strong 10.9%, higher than most bonds and bond sub-asset classes. Only niche securities and investments yield more, including mREITs, BDCs, and CLO equity tranches.

FLBL itself sports a 9.1% SEC yield, quite a bit lower than expected. Expenses are partly responsible, as is the fact that it generally takes a few months for rate hikes to impact investment markets.

FLBL yields quite a bit more than high-yield corporate bond ETFs:

It has outperformed since early 2022, when the Fed started to hike:

In my opinion, FLBL has enough credit risk to be an unsuitable investment for very risk-averse income investors and retirees. For those willing to accept a moderate amount of risk, the fund's 9.1% SEC yield seems quite attractive.

CLOZ - BB-rated CLOs

The Panagram BBB-B Clo ETF ( CLOZ ) invests in BB-rated CLO tranches of senior secured loans.

Credit risk is technically quite low, with BB-rated tranches defaulting at an annual rate of 0.02%.

Defaults would increase during recessions. In my opinion, due to structural issues with these investments, defaults could, potentially, significantly increase during a recession. As such, CLOZ does have some / moderate credit risk, notwithstanding the figures above.

CLOZ sports a 9.9% SEC yield, higher than that of high-yield corporate bonds, which seems like the closest fixed-rate analogue to the fund:

CLOZ has outperformed said securities since inception as well:

CLOZ is a relatively young fund, with inception in January of this year. The fund is quite small too, with $137M in AUMs. Volume is sometimes low, although Seeking Alpha is currently showing a respectable volume of 99,269 shares. Both figures were lower in prior months, so the fund seems to be growing quite rapidly.

In my opinion, the issues above are not all that significant. Other investors might disagree.

I last covered CLOZ here.

BIZD - BDCs

The VanEck Vectors BDC Income ETF ( BIZD ) invests in business development companies, or BDCs. BDCs provide financing to corporations. Said financing generally takes the form of floating rate loans to smaller, riskier, companies with weak credit ratings. Details and percentages vary.

Credit risk is quite high, due to BDCs focusing on riskier issuers. BDCs themselves are generally leveraged, boosting risks further.

Dividends and yields tend to be quite strong, with BIZD sporting an 11.2% SEC yield. Very few asset classes yield more.

Strong dividends have led to reasonably good returns these past few years, with BIZD outperforming most asset classes since early 2022. It has underperformed relative to most other floating rate securities, including senior loans.

As BIZD focuses on companies , share prices are strongly dependent and influenced by issues of valuation, sentiment, and growth. Arguably, the fund is not a floating rate fund, but the portfolios of the fund's underlying holdings certainly are, and that seemed close enough to me.

BIZD is a relatively risky fund, and dependent on quite a few factors other than rates. Conservative, risk-averse investors might prefer other funds. Some might prefer the simplicity and more straightforward exposure to interest rates of a fund like USFR or FLBL.

I last covered BIZD here .

AFT - Senior Loans Leveraged CEF

The Apollo Senior Floating Rate Fund ( AFT ) is a leveraged CEF focusing on senior loans. AFT's leverage amplifies distributions, returns, risk, and volatility vis a vis FLBL and other senior loan ETFs. AFT currently trades with a 14.8% discount, higher than the CEF average, and higher than the fund's own historical average. AFT sports an 11.2% distribution yield.

In my opinion, AFT seems like a particularly compelling choice for investors seeking comparatively high dividends, and willing to stomach the added risk and volatility.

I chose AFT over other senior loan CEFs due to the fund's above-average NAV return and discount. There are lots of other possible choices here, most of them quite good.

I last covered AFT here .

XFLT - Senior Loans and CLOs

The XAI Octagon Floating Rate & Alternative Income Term Trust ( XFLT ) is a leveraged CEF focusing on senior loans, but with significant investments in CLO tranches, both equity and debt. Think of the fund as a combination of FLBL, JAAA, JBBB, CLOZ, and something like the Eagle Point Credit Co LLC ( ECC ).

Credit risk and volatility are both quite high, due to the fund's choice of holdings, and use of leverage.

XFLT also sports a 13.9% distribution yield, and fully covered by underlying generation of income.

XFLT seems like a particularly compelling investment opportunity for investors seeking high dividends and diversification.

I last covered XFLT here .

Conclusion

Floating rate securities offer investors strong, growing dividends, and low rate risk. There are several floating rate funds available in the market today, with different characteristics, and with credit risk appropriate for most types of investors. I've provided investors with a quick overview of nine of these funds, as a starting point for a deeper dive into the same. Hopefully this article was of use and interest to readers.

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