Should you invest in floating-rate Treasury ETFs?

WisdomTree Investments and State Street Global Advisors wasted no time getting ready to launch exchange-traded funds that will track the U.S. Treasury's latest innovation: floating-rate Treasuries. Both ETF companies filed with the Securities and Exchange Commission last week to offer funds that will track the floating-rate Treasury market, even though the market won't exist until late January. If the interest in floating-rate bank loan mutual funds is any indication, floating-rate Treasuries clearly have the potential to create a lot of demand. Bank loan mutual funds, which hold short-term, below-investment-grade credit with floating interest payments, attracted $54.3 billion of net inflows this year through October, the most of any mutual fund category, according to Morningstar Inc. “In the fixed-income space, [there are] not many places for companies to create new funds,” said Tim Strauts, an analyst at Morningstar. “If the government says it's going to create a new security, firms are going to get their prospectuses in right away.” But whether there is demand from financial advisers and individual investors is a big question because while floating-rate ETFs might provide some protection against rising rates, they will offer next to nothing in terms of income. The fixed-rate two-year Treasury is currently yielding around 0.3%, so a floating-rate version of the same debt security will offer even less in exchange for its protection against rising interest rates. Since the ETFs aren't likely to be free — although neither WisdomTree nor State Street listed an expense ratio in the initial filings — the paltry yield will be even less once expenses are taken into account. “You need a base T-bill rate that's somewhere north of zero to make it very attractive for a fund that's also charging for their management,” said Melissa Joy, director of investments at the Center for Financial Planning Inc., a Southfield, Mich.-based registered investment adviser. “Until interest rates rise, there's really no point to a floating-rate Treasury fund,” Mr. Strauts said. “Floating-rate Treasuries make sense for the government, but for actual investors, there probably are better options.” One alternative that Mr. Strauts pointed out is a money market fund. They may only offer 0.01% interest today, but they reset their interest payments every 30 days. Last week, the Treasury announced that it would hold its first auction of floating rate Treasuries on Jan. 29. The initial auction will be for floating-rate Treasuries with a duration of two years. Between $10 billion and $15 billion of the securities are expected to be sold. Interest rates on floating-rate Treasuries will be reset weekly, according to the result of the most recent 13-week T-bill auction, plus a spread. The combination seemingly eliminates the risk of rising interest rates, since bond prices move inversely to interest rates. This year, investors have seen first-hand what rising interest rates can do to a bond portfolio. Yield on the 10-year Treasury rose to 2.71% on Nov. 15 from 1.6% at the beginning of May. The Barclays U.S. Aggregate Bond Index has subsequently lost more than 3.5% over that time period. Of course, just because WisdomTree and State Street have filed for permission to offer floating-rate Treasury ETFs doesn't mean they have to launch them anytime soon. Jessica Zaloom, spokeswoman for WisdomTree, declined to comment. Troy Mayclim, spokesman for State Street, did not respond by press time.