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When interest rates are threatening to rise, many income investors hesitate to lock in fixed rate coupons. The use of Fixed to Floating or Floating-Rate securities in an income generating strategy could be a solution for obtaining higher yields with investment grade securities as rates rise.
A floating rate structured security has a variable interest rate which is tied to a reference rate. Common reference rates include the 3-month LIBOR (London Interbank Offer Rate) and the Consumer Price Index (CPI).
Once the reference rate has been established, the issuer will determine the spread it is willing to pay above the reference rate, let’s say 200 bps. And finally, the issuer will determine a reset period which designates how often the interest rate is adjusted, which could be daily, monthly, quarterly, or annually. The coupon for this security would then read something like “Quarterly Reset, 3-month LIBOR + 200bps”.
Fixed to Floating Rate preferred securities offer a fixed coupon until a certain date, when they become floaters.
What are we thinking?
Compared to traditional fixed rate securities, floating rate securities offer some interest rate risk protection, pay higher yields as rates rise, are less rate sensitive than Treasury yields, and are not as price sensitive since coupons change when the market rate changes.
By incorporating Fixed to Floating rate preferred securities into CIP’s preferred allocation, we believe we are offering an attractive solution for income investors who are looking for conservative allocations and additional yield. And as active managers, we monitor the reference rates, credit, and call risks.
Source: Raymond James
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