USFR - USFR: When Everybody Is Greedy Increase Your Cash Balance 5.2% Yield

2023-07-21 13:43:21 ET

Summary

• USFR is an ETF that tracks the performance of floating rate Treasury notes.
• Floating rate Treasury notes have a very short duration and are able to capture the move higher in interest rates.
• USFR has outperformed all its comparables in the past year, and it is currently yielding 5.2%.
• With greed currently prevailing in the equity markets as seen from the AAII surveys, a retail investor would be well served to sell some equity exposure and increase their cash balance via USFR.

Thesis

The WisdomTree Floating Rate Treasury Fund ETF ( USFR ) is an exchange traded fund. As per its literature:

The WisdomTree Floating Rate Treasury Fund seeks to track the price and yield performance, before fees and expenses, of an index that measures the performance of the market for floating rate public obligations of the U.S. Treasury.

Source: Fact Sheet

Floating rate Treasuries are a bit of a niche market, with most market participants familiar with the tenor and yield grid for the most traded part of the market, namely fixed rate Treasuries. U.S. government floating rate notes are priced at a spread over 3-month T-bills, thus have a very short duration profile and are able to capture the move higher in interest rates. To that end, this fund has a duration of 0.02 years and a current 30-day SEC Yield of 5.2%.

USFR can be considered a cash equivalent given the AAA rating of the underlying notes and the de-minimis market risk. The question that an investor should ask is simply where the yield is for the fund. Please note, USFR has been more adapt at capturing the move higher in rates when compared to some of its peers, given its floating rate nature:

USFR has outperformed all its comparables in the past year, with the closest matching performance coming from the iShares 0-3 Month Treasury Bond ETF ( SGOV ).

In the below 'State of the Capital Markets' section, we give readers a take on the current equity market rally, our views on the overbought conditions, with the intent of underlying the importance in crystalizing some of those equity market gains and increasing one's cash balance at this stage. USFR represents a great cash equivalent, where a retail investor can obtain yields of 5.2%.

Analytics

• AUM: $17.3 billion
• Sharpe Ratio: -0.71 (3Y)
• Std. Deviation: 0.58 (3Y)
• Yield: 5.2%
• Premium/Discount to NAV: N/A
• Z-Stat: N/A
• Leverage Ratio: 0%
• Composition: Fixed Income - Treasury FRNs
• Duration: 0.02 yrs
• Expense Ratio: 0.15%

State of the Capital Markets

Equity markets have been buoyant this year, against all expectations:

Technology via the Nasdaq has seen the largest rally, being up 41% as of the writing of this article. The main drivers for the Nasdaq and S&P 500 have been the tech mega-caps, which have had an astounding performance. The rally seems to be finally broadening, with the S&P 500 Equal Weight ETF ( RSP ) moving higher to an 11% return, followed by the Russell 2000 ( IWM ) at 8.95%.

Time will tell if this is just another bear market rally or the start of a new cyclical bull market, but we can say with confidence that greed is currently prevailing in the markets:

The CNN Fear & Greed indicator is pointing to Extreme Greed, a state of affairs which will likely not last forever. Similarly, the AAII Sentiment Survey is in greed territory and at 1-year highs after bottoming out at the end of September 2022:

If you caught the rally this year, then congrats, not many pundits were predicting such a strong showing for equities in 2023. The more pressing question at this stage though is 'what is next?'. Historically speaking, such overbought extremes are followed by corrections. A correction could be shallow (i.e., -5%) or more pronounced, depending on the underlying factors. However, overbought conditions do not last for extremely long periods of time, and we got a flavor of market moves via the Tesla ( TSLA ) and Netflix ( NFLX ) earnings this past week.

Fund Holdings

The fund only contains four positions:

Granularity is not important here since all assets are AAA and liquid. Floating rate notes are auctioned four times a year in January, April, July, and October and have two-year maturity dates. In terms of their re-setting features, please note:

The interest rate of an FRN is the sum of two components: an index rate and a spread.

• Index rate . This rate is tied to the highest accepted discount rate of the most recent 13-week Treasury bill. We auction the 13-week Treasury bill every week, so the index rate of an FRN is reset every week.
• Spread . The spread is a rate we apply to the index rate. The spread stays the same for the life of an FRN. The spread is determined at the auction when the FRN is first offered. The spread is the highest accepted discount margin in that auction.

The index rate plus the spread equals the interest rate.

Source: TreasuryDirect.gov

The index rate re-set feature is responsible for the fund's low duration and has been able to correctly capture the rise in rates on the front end of the curve.

Conclusion

USFR is an exchange traded fund containing Treasury securities. The fund covers a bit of a niche market, namely floating rate Treasury notes. The respective obligations come with the government's AAA rating but are floating rate, re-setting every week. With a low duration of 0.02 years and no credit risk, the fund can be considered a cash equivalent. The fund is now yielding 5.2% and will keep increasing its yield if the Fed raises rates further. With greed prevailing in the capital markets currently and overbought conditions being corrected violently at times, it is a good idea for a retail investor to move some money from equities to cash equivalents such as USFR.

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