1. Newsroom
  2. Time to look at floating-rate notes
Menu
Insight 14.02.2022

Time to look at floating-rate notes

Time to look at floating-rate notes

In this interview Mohammed Kazmi sets out to Bernard McGrath his case for investing in floating-rate notes as a way to reduce portfolio exposure to interest rates and gain from widely expected Fed rate hikes in the months ahead.


Bernard McGrath: In recent weeks, some of the larger central banks have pivoted towards raising rates. In fixed income markets, popularity for floating-rate notes has increased. Can you remind us what they are?

Mohammed Kazmi: Floating-rate notes (FRNs) are bonds issued with variable interest rates. At successive intervals, typically quarterly, the FRN coupon is reset according to a predetermined benchmark rate. Should the benchmark rate move up, as it does in a hiking cycle, the coupon on the FRN will increase as well.

Bernard: What about interest rate exposure, are FRNs affected by rising yields?

Mohammed: As a consequence of the frequent coupon reset, FRNs have little or no interest rate duration, meaning they do not suffer capital losses from rising yields. In addition, an FRN’s coupon increases in a hiking cycle, which means it can be a very interesting segment of the market to have exposure to at this current juncture.

Bernard: Fixed income markets have responded to the expectation of future rate hikes. Is it too late to go into FRNs?

Mohammed: Whereas fixed-coupon bonds have adjusted yields in anticipation of seven future rate hikes over the coming two years, FRNs do not respond until actual hikes are delivered. Investors still wishing to take advantage of the hiking cycle can therefore still position themselves in FRNs today and benefit.

Bernard: What about supply? Are these bonds available and are they liquid?

Mohammed: Supply and demand for FRNs is directly linked to the central bank cycle. If central banks are hiking rates, demand for FRNs increases and corporates respond by issuing more FRNs. Similarly, if central banks are cutting rates, investor demand for FRNs decreases and fewer are issued. With the hiking cycle beginning in the US, already started in the UK, and expected by year-end in Europe, investor demand for FRNs has increased. Corporates have responded and supply is increasing too. As for liquidity, investment-grade FRNs are very liquid, with tight bid/offer spreads in the market.

Bernard: As FRNs have no interest rate exposure, the risk for these instruments is on the credit side. How are investment-grade companies from a fundamental perspective?

Mohammed: We see investment-grade companies as being in a strong position from both a macro and a micro perspective. Credit fundamentals are impressive, following stellar earnings growth in 2021 with prudent balance sheet management. This can be seen in net leverage for US investment-grade names, which have fully reversed the increase observed during the pandemic. From a macro perspective we expect growth to be resilient as economies look to move on from the pandemic, and it is the strength of the US economy and labour market that has allowed the Fed to focus more on inflation.

Global & Absolute Return Fixed Income
Bernard McGrath Bernard McGrath
Senior Investment Specialist
VIEW HIS LINKEDIN PROFILE
Mohammed Kazmi Mohammed Kazmi
Portfolio Manager
VIEW HIS LINKEDIN PROFILE
Expertise

Hedge funds

UBP is one of the longest-standing investors in hedge funds and a leading European player in the sector.


Further reading

Insight 12.09.2023

Tricky times for gold

Finanz und Wirtschaft (09.09.2023) - Over the summer months, gold has struggled to rise in a meaningful manner. The metal traded in a relatively tight USD 100 range this summer, roughly between USD 1,890 and USD 1,990. Gold price volatility continued to decline, and the latest one-month implied volatility is only 10%, the lowest in years. This shows that markets do not expect any sharp moves in either direction over the coming months.

Insight 30.08.2023

Reversing obesity to lighten the load on health and the economy

With obesity on the rise all over the world despite efforts to reverse the trend, impact investors need to join the fray alongside policymakers to reduce the increased mortality and the costs caused by the condition.

Insight 19.07.2023

China can evade a balance sheet recession

China’s economy decelerated in Q2-23, led by a sequential decline in manufacturing and investment. Services continue to expand at a slower pace. Below potential growth is resulting in rising unemployment in April and May.