USFR - USFR: Simple Floating Rate Treasury ETF Low Credit And Interest Rate Risk Growing 5.1% Yield

2023-04-12 03:34:54 ET

Summary

• USFR invests in floating-rate treasury notes.
• These are treasuries with variable rates of interest, benchmarked to 3M t-bills.
• They perform similarly to t-bills but yield a bit more.
• An overview of USFR follows.

Author's note: This article was released to CEF/ETF Income Laboratory members on March 31th.

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 have risen these past few months, as the Fed hikes rates. USFR's extremely low credit and interest rate risk, and good, growing 5.1% forward yield make the fund a buy.

USFR - Quick Overview

USFR's underlying holdings are treasuries with variable interest rates. Rates are reset weekly, and are (currently) equivalent to 3M t-bill rates plus 0.20%. Higher t-bill rates mean higher rates for USFR's underlying securities, and for the fund itself. Interest is paid quarterly. See here for more details.

USFR - Benefits

Extremely Low Credit Risk

USFR's treasury investments have extremely low credit risk, as said securities are issued the United States Federal Government, the strongest, most credit-worthy institution in the world. Treasuries will almost certainly be repaid, in full, at maturity, barring an unprecedented U.S. government default.

USFR's low credit risk helps ensure long-term capital stability, and significantly, almost totally, reduces the probability of long-term capital losses.

Low credit risk serves to minimize losses during downturns and recessions. Expect approximately zero losses during these scenarios, which should result in outperformance relative to equities and other risky assets during the same. Performance is comparable to that of t-bills. Longer-term fixed-rate treasuries perform even better, however.

USFR's extremely low credit risk is an important benefit for the fund and its shareholders.

Extremely Low Interest Rate Risk

USFR has extremely low interest rate risk, for two key reasons.

First, and most importantly, because the fund focuses on floating rate treasuries, which almost immediately see higher coupon rates when interest rates increase. Investors in long-term treasuries might be stuck with low-yielding securities for decades if rates continue to skyrocket, while USFR investors would have to wait one week for their investments to start yielding more.

On a slightly more negative note, it might take the fund a few months to start actually receiving higher interest payments, and a few months still for investors to receive higher dividends. This is something of a worst-case scenario, and has not occurred in the past, but might happen in the future.

Second, is the fact that the fund focuses on short-term treasuries, with maturities of around 1 year. Short-term securities mature quickly, and so can be quickly replaced when rates rise. As USFR's securities have floating rates maturities are less of a concern, but these still matter as spreads could rise too.

Due to the above, USFR's share price should remain stable during periods of rising interest rates, leading to outperformance during the same. This was the case during 2022, a period of skyrocketing rates, as expected. USFR's performance was comparable, very slightly stronger, to that of t-bills.

USFR's extremely low interest risk is an important benefit for the fund and its shareholders, and one which is particularly important during a period of rising interest rates.

Growing 5.1% Forward Yield

As per the U.S. treasury, floating rate treasury note rates are currently equivalent to 3-month t-bill rates plus 0.20%. Said t-bills currently yield 5.08%.

USFR's dividend yield should equal prevailing floating rate treasury note rates, minus expenses (0.15%). Do a little math on the above, and USFR should be yielding around 5.1% right now. Current TTM yields are quite a bit lower, at 2.9%, as these take into consideration dividend payments from 2022, during which rates / dividends were much lower. The aforementioned 5.1% figure is much more reflective of future expected dividends, so I took said figures as the fund's forward yield. Annualizing the fund's latest monthly dividend payment nets me 4.7%, much closer to that 5.1% too.

USFR's floating rate treasuries directly benefit from higher interest rates. These are rising, as the Fed continues to take steps to combat elevated inflation. USFR's dividends should have seen strong growth in the recent past, as has indeed been the case (the noticeable drop was a tiny special distribution in late 2022, which can be safely ignored).

Fund dividends should continue to see strong growth moving forward, contingent on future Fed hikes. These seem likely, as per recent Fed comments . Financial sector stress could cause the Fed to pause hiking, perhaps even pivot towards rate cuts, however. Growth still seems likelier than not, but growth is definitely not certain.

USFR's good, growing 5.1% forward yield is an important benefit for the fund and its shareholders.

As an aside, in case it was not completely clear, USFR's underlying holdings, floating rate treasury notes, generally yield more than t-bills, currently 0.20% more. Spreads do vary, but tend to be positive, and benefit USFR vis a vis t-bills.

Drawbacks

USFR is a relatively safe, stable fund, without any significant drawbacks. It does, however, have some minor issues which investors need to consider.

Some Funds and Asset Classes Yield More

USFR's 5.1% forward yield is quite good on an absolute and historical basis, but it is lower than that of many other asset classes and large ETFs. High-yield corporate bonds yield a lot more, as do most CEFs and BDCs. CLOs and investment-grade corporate bonds yield a bit more, even those with very strong credit ratings. Covered call equity ETFs also yield more, as do some broader dividend equity ETFs. USFR's 5.1% forward yield is good, but definitely not great.

Considering the above, more aggressive, yield-seeking investors could consider alternatives to USFR. I covered three with particularly strong, growing yields here .

Expenses

USFR sports a 0.15% expense ratio, quite low on an absolute basis, and in-line with industry averages. Although USFR's expenses are not particularly high, these do directly reduce the fund's dividends and returns, a small negative for investors. Some investors might wish to avoid these expenses by buying treasury notes though TreasuryDirect . Others might prefer the (assumed) simplicity of an ETF, and the extra liquidity doesn't hurt either. In any case, both are valid options, but I'm sure some investors would prefer to avoid USFR's expenses.

Taxes

USFR's investors must pay federal income tax on their earned interest/dividend payments. Investors in higher tax brackets could consider more tax-advantaged investments, including municipal bonds.

Conclusion

The WisdomTree Floating Rate Treasury ETF invests in floating rate treasury notes. These securities behave similar to t-bills, with low interest rate risk and stable prices. Yields have risen these past few months, as the Fed hikes rates. USFR's extremely low credit and interest rate risk, and good, growing 5.1% forward yield make the fund a buy.

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