Introduction
In late 2022, T. Rowe Price added the T. Rowe Price Floating Rate ETF (NYSEARCA:TFLR) to their expanding fixed income lineup of ETFs, this being the fourth such offering. At the time, investors were flocking to floating-rate funds for price protection that comes when interest rates, thanks to the FOMC inflation fighting tactic of raising the Federal Funds Rate.
Based on when the hikes started and possibly ended, the TFLR ETF was late to the game. Along with reviewing this ETF, I will compare how its performance matches up with more seasoned ETFs and CEFs that it competes against for investors' dollars. While TFLR rates a Hold for speculative investors due to its low-quality portfolio, for that reason I give it a Sell rating for all other investors.
T. Rowe Price Floating Rate ETF review
Seeking Alpha describes (edited) this ETF as:
The T. Rowe Price Floating Rate ETF invests in investment grade floating rate loans and other floating rate debt securities of varying maturity. It employs fundamental analysis to create its portfolio. The ETF was formed on November 16, 2022. The investment seeks high current income and, secondarily, capital appreciation. The fund will normally invest at least 80% of its net assets (including any borrowings for investment purposes) in floating rate loans and floating rate debt securities. Most assets will typically be invested in U.S. dollar-denominated floating rate loans and debt instruments, including U.S. dollar-denominated bonds or loans of foreign issuers or lenders. The fund may also invest up to 20% of its total assets in non-U.S. dollar-denominated investments.
Source: Seeking Alpha
TFLR has $137m in AUM and has a fee I consider on the high side for today's environment: 60bps. The managers list the 30-day SEC yield as 8.26%.
Holdings review
TFLR webpage only provided holdings data and supporting data for industry exposure. These are the ones with at least 4% exposure.
The top 4 industries account for over 50% of the portfolio. I had to turn to Morningstar for the other allocation data, and it's from 12/31/23. Next up is credit ratings, which is very concerning if the economy goes into a recession.
So, not only is 93% of the portfolio below investment grade, but most of that is not even rated near the top of the "junk" ratings. Maturity-wise, the portfolio is on the short side, with a duration of only .59 years, and the WAM being longer at 4.25 years. The schedule looks like this, with the portfolio experiencing an 18% turnover rate.
Data provided included the coupon spread for TFLR, which Morningstar lists the WAC at 9.15%.
10%+ coupons are great, assuming the issue doesn't default. Over 80% of the allocation is in 8+% coupons.
Top holdings
These Top 20 bonds account for 27+% of the portfolio, out of about 300 positions. The actual largest position is an 8+% allocation to a TRP cash fund. To keep the data in sync, holdings data is from 12/31/23 too, even though newer TFLR data was available.
Distribution review
TFLR payouts indicate they failed to capture the higher coupons or yields available during a time when the FOMC was aggressively fighting inflation with historic rate hikes. I'm sure some of the lack of capture was due to FOMC actions mainly affecting the short end of the yield curve.
Comparing funds
In one sense, being late to the end should have benefited TFLR as prices would have been pushed down versus 2021, despite the floating-rate nature of the assets purchased as investors supplied the funds. For this, I chose the following funds as they seemed to be a good mixture:
- iShares Floating Rate Bond ETF (FLOT)
- Invesco Senior Loan ETF (BKLN)
- Nuveen Floating Rate Income Fund (JFR)
- PennantPark Floating Rate Capital (PFLT)
The difference in the ETFs is, like TFLR, BKLN invests in non-investment-grade debt; FLOT holds higher rated debt. JFR is a CEF that employs leverage and PFLT uses the BDC model for its portfolio construction. The common point is they all use floating-rate debt.
Since December of 2022, BUCK only outperformed the IG ETF, FLOT, but when looking at the two risk ratios, it placed second in both the Sharpe and Sortino ratios. It also compared well when looking at the Worst Year and Max Drawdown data. For both the CEF and BDC, the higher risk structures used become apparent.
Portfolio strategy
One should ask if floating rate ETFs, which in theory, should outperform fixed-rate ETFs when rates are climbing. To test that, I compared TFLR to the SPDR Bloomberg High Yield Bond ETF (JNK).
While a limited sample, compared to the JNK ETF, TFLR did achieve the goal of providing not only a better CAGR but so with less variation in price since late 2022.
The question facing investors now seems to be becoming even more murky; when and by how much will the FOMC reduce the Fed Funds rate from its current level. The latest FFR Plot chart points to at least two 25bps cuts should be in the mix for 2024, with more reductions in 2025 and 2026.
If this comes to pass, fixed income investors should benefit by elongating their duration and holding a larger percent of fixed-rate debt. If they fear the "soft landing" won't happen and a recession will, owning investment-grade debt should be considered.
Final thoughts
Following the long-held belief that investors should not "fight the Fed", I give the TFLR ETF only a Hold rating for those who are light on floating-rate, sub-investment-grade exposure, and a Sell rating for the other investors. I would be going farther out the yield curve and avoiding ETFs where 75+% of the portfolio is rated at B or below.
Alex Pettee is President and Director of Research and ETFs at Hoya Capital. Hoya manages institutional and individual portfolios of publicly traded real estate securities. Alex leads the investing group known as the Hoya Capital Income Builder, which uses the investment knowledge of several Seeking Alpha analysts provide members with insightful articles covering mostly individual stocks or funds. Occasionally an article cover will cover an investing strategy or other topic that investors need to be aware of, such as law changes that might effect their long-term strategy.
For more information about this Investors Group, click on this link:
https://seekingalpha.com/instablog/1723581-hoya-capital/5350609-retired-investor-teams-up-income-builder
