ETF Analysis - iShares Floating Rate Bond ETF (FLOT)

TLDR

• It is suitable for the idle money rolling during the interest rate hike

• It is suitable for the operation of extra funds of dollar investment funds, but you should not exchange money for this.

• The yield is around 2% per year, and the risk is considered to be very small.

Summary

The ETF is an iShare (ETF brand of the world's largest fund management company, BlackRock) ETF series, one of the bond management products, which is an exchange traded fund (ETF) that is linked to floating interest rates. You can buy and sell with an overseas stock account. However, you have to understand the fact that it is meaningful when you hold it for a long time since the foreign stock commission is not cheap and exchange commission is almost about 0.5% when the stock is bought and sold,

This ETF is linked to variable interest rates, so interest income increases as the US interest rate rises. The Fed's benchmark interest rate is set at 1.5 to 1.75%, and is expected to reach 2% this year. As a matter of fact, the interest rate is going up, and the bond value is going to fall. If interest rates go up, the decline in bond value will only result in a higher yield, since bond prices will have to decline in order to match the actual yield of bonds that give the existing fixed rate. It’s not math, it’s just common sense.

Since interest rates are rising, bond prices are falling, and stock market rises have declined, now deposits are the answer. However, interest rates on deposits SUCK anyway. The interest rate on US fixed deposit rates is not even 0.5%. Then, it is better to buy floating rate bonds with the same profit structure as deposits. But where do individuals buy floating interest rate bonds? If you do not have much money, you cannot buy them. So it is efficient to buy a set of floating interest rate bonds covered by ETFs. The management fee of the fund is about 0.2%, and it will take your money once more with the bid offer spread, but I think it is more efficient than the deposit.

Price and Expected Return

The current price is 50.89 USD, and the yield from the beginning of the year is 0.73%. Even if there is no interest rate hike by the end of the year, it can earn about 2%. The NAV of the fund continues to rise with interlocked benchmark interest rate whether the interest rate rises or falls. However, if the benchmark interest rate falls below 0.25% (it was like that for few years after the financial crisis), it could be negative if the management fee is paid. But such a thing is very unusual, and even so, it is difficult for NAV to drop sharply. If negative interest rates occur in the future, let's resale our funds and buy stocks that plummet with the money. The negative interest means that the economy has been smashed real hard. If you carry your fund and take some losses and buy all the blue chips, maybe you can turn your life around. Or buy a new car. The annual volatility of the Fund is about 0.4%, considering the volatility of the common stock is about 15 ~ 45%, we can just assume that it is not moving.

The above picture shows the NAV trend, which has been rising steadily, and the US rate hike has been full-fledged since 2H06, and the NAV has been increasing steadily after. Well, it's just a matter of course. In 2011~2012, when the market liquidity had deteriorated, there was only 2 ~ 3% loss on NAV. As liquidity premiums were resolved within a year, NAV returned to normal.

Risk

This fund is a fund that manages IG (Investment Grade) bonds and thus has a considerably small risk. The number of asset holdings is 640 and is well diversified. The size of the set amount is around $ 8 billion, so the liquidity of investors will be quite good. The biggest risk is transaction costs.

1. Liquidity Risk

   The NAV of the fund is about $ 8 billion, so it is safe to assume that there is no liquidity risk. Liquidity risk is not that difficult. If I bought it and cannot sell it at the right price, then it is a liquidity risk. We cannot afford to give a bid offer spread of 1% to a fund with an annual return of 2% or more. Well, I think that is very unlikely to happen for this fund because the size of the fund is huge.

2. Credit Risk

   The rating of the bonds held by the Fund is 12.9% of AAA, 21.2% of AA, 46.48% of A, and 18.99% of BBB, and BBB is the AA rating of Korean credit-rating agency. Most domestic (Korean) large securities firms are AA. There are 640 types of bonds held, all of which are investment grade bonds. In general, corporate default rates are in the range of 0.5% to 4.2% (5 to 42 out of 1000 companies are annually destroyed). It was the worst in 2009 with 4.2%. The default rate of the investment grade is estimated to be 0.3 ~ 0.4%. The default rate of investment grade bonds since 2010 is almost zero. So even if we conservatively assume a 0.4% default rate, our yields will be over 1.6% this year. In short, it is a structure that is hard to lose money even in the worst case.

   

   As you can see from the chart above, the default rate of investment grade is nearly 0. However, the speculative grade and the total default rate are rising. After the sub-prime mortgage crisis in 2008, global credit rating agencies have been criticized so hard, the requirement for investment grade has become unbelievably strict since 2010. I believe that the sub-prime mortgage crisis has occurred because credit rating agencies gave out investment grade easily, especially AAA. Maybe I will get sued, but anyway…

3. Others

   The weighted average maturity of the fund is about two years and the duration is about 0.15. For the ease of understanding, the duration is just an interest rate sensitivity, and interest rate sensitivity can be considered to be 0.15% NAV fluctuation (0.15% decrease in fund when 1% increase in interest rate) when the interest rate changes by 1%. Anyway, even if it is small, when the interest rate is raised, the loss will occur in proportion to the time until the interest payment date of the remaining bond. However, if you hold it until maturity, you will return to the originally expected rate of return, since you will receive the interest rate again after the next interest rate decision (interest rate fixing). In conclusion, it will yield expected return at the time of investment start.

Conclusion

This fund is meaningful only to the people who have funds to invest in dollars, or for those who will hold the dollar for a long period of time. If the Korean won investor holds it for a short term of one to two years and then re-exchanges money after interest is paid, after exchange fees, transaction fees, and management fees are paid, only the principal will remain. However, it is not a bad to have one or two months' worth of funds if you do not really want know what to do with dollar and do not wishes to deposit it in the bank. The biggest problem with these low-risk bond ETFs is transaction fees, and I hope you find a way to solve the problem.

Closing

The fund also has Apple bonds. Become an Apple Creditor!

I was just joking.

Investment is entirely individual responsibility. Considering you're just investing in dollars, but do not know where to invest, unless you are making a dollar loan business, then, just hold the fund for a long time and exchange it back to Korean Won when the exchange rate is in your favor. You cannot really get a 2% interest rate from the bank with dollar. Of course, there are places where the interest rate on the dollar deposits is 4-5% such as India or Emerging Market, but then there is no guarantee that they will go bankrupt or not. Holding the fund during the interest rate hike and if you are a bond investor, investing in a long-term US bond, will not let you down I guess. The yield on Korean short-term funds is about 2~2.5%. However, if you have can get 2% with dollars, then there is no reason to have a risky asset such as Korean Won.