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Thursday, June 28, 2012

A Floating Rate Note Exchange Traded Fund

One of the challenges facing investors today is the pathetic rate on cash equivalents.  Treasury bills and money market funds yield barely above zero.  Adding any duration in a quest for better yield involves taking on interest rate risk, and this needs careful monitoring.  Simply, if and when rates rise, bond prices will drop.  If they rise far enough and fast enough, bonds and funds with high duration could experience significant capital loss.

This challenge is very real for investors following an asset allocation strategy that calls for 10%, say, in cash.  With the rates noted above, the cash portion will fall behind inflation over time. 

One possibility investors can consider to mitigate this possibility, or at least to hedge against it to an extent, is with a floating rate note fund.  Granted the yield won't knock your socks off, but it will yield more than money markets and won't be impacted by falling bond prices.

An example is FLOT.  FLOT yields 1.24% - not the greatest yield around but a heck of a lot better than money markets! - and has an average investment grade credit rating of A.  In comparison, a 1-year CD will yield approximately 1% fixed,  plus you essentially lock up your funds for a year.

Morningstar has the necessary information to analyze FLOT.  You'll find there that effective duration is a mere .13 years, which means the prices of its underlying issues will be stable.

As always, I would limit exposure to 5% of total assets in a fund of this type.  FLOT is an exchange traded fund and, therefore, unlike a mutual fund.  This needs to be taken into account when buying and selling.

Disclosure:  This post is for informational purposes only.  Before making investment decisions, individuals should do their own research or consult with a professional.  I own this fund for my clients.

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