If you are looking for something new and exciting in the investment world, you may want to take a look at the U.S. Treasury's latest offering: floating rate notes (FRNs).
First offered for sale on Jan. 29, FRNs are the first new Treasury offering in 15 years. They can help diversify an investor’s portfolio by protecting against a rise in interest rates. That’s an important consideration for many investors, since rising rates could affect the value of an individual's bond portfolio. Best of all, FRNs are guaranteed by the full faith and credit of the U.S. government, so risk-averse investors can sleep better at night.
So, what exactly are FRNs, and how do they differ from other investment options, such as Treasury Inflation Protected Securities (TIPS), which have become an important asset class since being introduced in 1997.
First, the inaugural FRNs have two-year maturities, although it’s possible that the Treasury might decide to issue new FRNs with durations of one to 10 years, based on the market response. Overall, the Treasury expects to issue about $130 billion in FRNs in the first year.
TIPS are issued in terms of 5, 10, and 30 years. While there is a strong secondary market for TIPS, investors should think about the length of time they want to tie up their money in TIPS or FRNs before making a decision between the two assets.
Interest will be paid on a quarterly basis, so investors could expect to receive four payments a year. The interest rate for FRNs may be adjusted weekly, based on changes to the three-month T-bill auction rate. That’s different from the rate calculations used for TIPS, whose principal is adjusted based on changes in the Consumer Price Index.
Initially, the U.S. Treasury expects most demand for FRNs to come from investors who now are using money market funds and other short-term securities as a “safe” place to park their money. FRNs are sold in increments of $100 and the minimum purchase is $100.
However, it is not yet clear how much demand there would be for the repurchase or sale of FRNs on the secondary market. Many investors may take a “wait and see” attitude toward the new securities. Therefore, FRNs may not be as liquid as money market funds — at least in the near future.
Another issue to consider is the possibility of a decline in interest rates before the FRN reaches maturity. If rates go up, then these securities would deliver a higher return to the investor. But if rates go down, that income stream would decline as well.
One of the more intriguing aspects of FRNs is that they could be an early indicator of a possible shift in the financial markets away from fixed-rate securities toward floating-rate corporate and municipal bonds. That would be a significant change in how governments, public agencies and private companies finance their debt.
If you have a significant amount of your portfolio in fixed-rate securities, you should be aware of this possible trend and discuss the implications with your financial advisor.
Andrew Menachem, CIMA, is a Wealth Advisor at the Menachem Wealth Management Group at Morgan Stanley in Aventura and teaches at the University of Miami. Views expressed are those of the author, not necessarily Morgan Stanley, and are not a solicitation to buy or sell any security. The strategies and/or investments referenced may not be suitable for all investors.