Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 281

Floating rate bonds rise in popularity

Today’s market poses a conundrum for bond investors. On the one hand, volatility stemming from rising trade tensions, and China’s slowing growth, are driving investors towards bonds as a traditional portfolio shelter. On the other hand, central banks around the world are tightening policy and conventional investment wisdom dictates that bonds do not perform well in a rising rate environment. What many investors are missing out on is the fact that floating rate bonds allow both portfolio protection and consistent returns. They can minimise the impact of rising rates on a bond portfolio. Interest rate risk is almost non-existent and the bonds are typically more capital stable. Citi has seen a five-fold increase in year-to-date investment in floating rate bonds by investors compared to the same period over 2017.

Investors are attracted to this asset class as floating rate bonds offer investors the inherent advantages of bonds, such as regular income and portfolio shelter in time of market stress, while also benefitting from rising rates. However, many investors have not heard of floating rate bonds and therefore have not included them in their portfolio.

Accessing floating rate bonds

Individual floating rate bonds typically are not accessible to many 'retail' investors due to regulatory restrictions. At Citi, only 'wholesale' investors have access. To be defined as a wholesale investor, a client needs a qualified accountant’s certificate stating they have net assets of at least $2.5 million, or a gross income for each of the last two financial years of at least $250,000.

Certified clients can access products that may be country specific or a multinational corporate giving exposure to a thematic like renewables or communications.

There are a few other ways that investors can access these investment benefits, including via ASX-listed floating rate ETFs and bonds, exchange-traded bonds issued by companies like XTB, and unlisted funds. Listed floating rate bonds provide an option for retail investors but they do not cover the wide range of borrowers available in the unlisted market. Wholesale investors can access traditional floating rate bonds by tapping into a global reach and a larger offering with potentially more attractive yields. Some other brokers allow access to certain bonds in 'retail' parcels.

How they work

Floating rate bonds pay a coupon that resets periodically and is based on a benchmark short-term interest rate index. For USD bonds, the regular coupon paid to investors is typically the 3-month Libor (London Interbank Offered Rate) plus a spread premium. For example, the coupon can be set at 3-month Libor + 2%. At current levels this would mean the investor earns 4.33% which is as compelling as most fixed rate bonds.

Typically, investors cite three main reasons for choosing floating rate bonds:

  • Short-term interest rates are expected to rise
  • As alternatives to term deposits for higher levels of income
  • To avoid the risk in fixed rate bonds of the bond’s price declining when interest rates move up

Rising popularity

Recently, purchases of both USD-denominated and AUD-denominated floating rate bonds have increased significantly. Investors are riding the Fed’s rate hiking cycle and are benefiting from expectations of higher short-term rates. The 3-month US Libor is now at its highest since 2008 and some economists expect the US benchmark to near 3.5% by the end of 2019.

Domestically, even though the RBA currently remains on hold, our economists consider the central bank maintains the view that the next move in interest rates is likely to be up.

As demand from investors for floating rate bonds has grown, supply has followed with strong creditworthy issuers offering a smorgasbord of choice. Floating rate bond issuances in USD-denominated and AUD-denominated have increased significantly in 2018.

These two bonds are examples that illustrate this point:

  • Barclays PLC issued a 5-year floating rate bond with a current coupon close to 4% that will increase as the Australian benchmark rate, the 90-day BBSW, increases.
  • China’s Far East Horizon offers a spread of 2% over the 3-month US Libor for 3 years.

While these two bonds have been the most popular with our clients in 2018 to date, each customer should consider their own needs and circumstances before deciding to invest.

With the market having priced one more Fed hike for 2018 and with the growing likelihood of a second one, investors look likely to continue turning to floating rate notes for both portfolio protection and consistent returns.

 

Elsa Ouattara is a fixed income strategist at Citi Australia. This article is for general information only and does not consider the specific circumstances of any individual.

 

4 Comments
Guy Brindley
November 22, 2018

It would have been useful to know how you access the two bonds listed and whether they are accessible to retail investors. If so code etc
Googling doesn't come up with anything or looking at ASX etc

Graham Hand
November 22, 2018

Hi Guy, the two bonds mentioned are not listed on the ASX. The article uses them to illustrate the types of bonds available via a 'broker'. Some fixed interest brokers (such as Mint Securities, soon to be BGC, and FIIG) allow access to retail parcels of unlisted bonds, but as the article says, there are many more bonds available to larger investors.

Warren Bird
November 23, 2018

"There are many more bonds available to larger investors." Which is how retail investors should access them, via managed funds. Hobby horse of mine, I know, but floating rate notes involve credit risk and to manage credit risk properly you not only have to do detailed credit risk analysis on each bond issuer, but also put together a highly diversified portfolio. That is, hundreds of issuers. Managed funds come into their own for providing that.

Certainly , retail investors should not buy just two securities! Or 10, or 20 like some brokers recommend. You need to make sure that if 1 or 2 go south, it doesn't wipe you out. So you want no more, usually, than 1% of your credit portfolio in any one name, especially if you're not in the position to do on-going credit research.

Pat
November 22, 2018

You only mention XTB and ETF's regarding the purchase of bonds where as there are other avenues such as through fixed interest brokers directly. Both Wholesale and Retail investors can invest through several brokers and they provide extensive research and updates on companies and bonds available, you also have access to FRN, FCN, IAB's, RMBS. I think an article like this should be more transparent and not push only items that Citi Australia trade.

 

Leave a Comment:

RELATED ARTICLES

Will the RBA cut rates before the Fed?

This 'forgotten' inflation indicator signals better times ahead

The markets to gain most from US rate cuts

banner

Most viewed in recent weeks

Australian house prices close in on world record

Sydney is set to become the world’s most expensive city for housing over the next 12 months, a new report shows. Our other major cities aren’t far behind unless there are major changes to improve housing affordability.

The case for the $3 million super tax

The Government's proposed tax has copped a lot of flack though I think it's a reasonable approach to improve the long-term sustainability of superannuation and the retirement income system. Here’s why.

Tariffs are a smokescreen to Trump's real endgame

Behind market volatility and tariff threats lies a deeper strategy. Trump’s real goal isn’t trade reform but managing America's massive debts, preserving bond market confidence, and preparing for potential QE.

The super tax and the defined benefits scandal

Australia's superannuation inequities date back to poor decisions made by Parliament two decades ago. If super for the wealthy needs resetting, so too does the defined benefits schemes for our public servants.

Meg on SMSFs: Withdrawing assets ahead of the $3m super tax

The super tax has caused an almighty scuffle, but for SMSFs impacted by the proposed tax, a big question remains: what should they do now? Here are ideas for those wanting to withdraw money from their SMSF.

Getting rich vs staying rich

Strategies to get rich versus stay rich are markedly different. Here is a look at the five main ways to get rich, including through work, business, investing and luck, as well as those that preserve wealth.

Latest Updates

SMSF strategies

Meg on SMSFs: Withdrawing assets ahead of the $3m super tax

The super tax has caused an almighty scuffle, but for SMSFs impacted by the proposed tax, a big question remains: what should they do now? Here are ideas for those wanting to withdraw money from their SMSF.

Superannuation

The huge cost of super tax concessions

The current net annual cost of superannuation tax subsidies is around $40 billion, growing to more than $110 billion by 2060. These subsidies have always been bad policy, representing a waste of taxpayers' money.

Planning

How to avoid inheritance fights

Inspired by the papal conclave, this explores how families can avoid post-death drama through honest conversations, better planning, and trial runs - so there are no surprises when it really matters.

Superannuation

Super contribution splitting

Super contribution splitting allows couples to divide before-tax contributions to super between spouses, maximizing savings. It’s not for everyone, but in the right circumstances, it can be a smart strategy worth exploring.

Economy

Trump vs Powell: Who will blink first?

The US economy faces an unprecedented clash in leadership styles, but the President and Fed Chair could both take a lesson from the other. Not least because the fiscal and monetary authorities need to work together.

Gold

Credit cuts, rising risks, and the case for gold

Shares trade at steep valuations despite higher risks of a recession. Amid doubts that a 60/40 portfolio can still provide enough protection through times of market stress, gold's record shines bright.

Investment strategies

Buffett acolyte warns passive investors of mediocre future returns

While Chris Bloomstan doesn't have the track record of his hero, it's impressive nonetheless. And he's recently warned that today has uncanny resemblances to the 1990s tech bubble and US returns are likely to be disappointing.

Sponsors

Alliances

© 2025 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.