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By Thomas Boccellari | 09-22-2014 11:00 AM

A Cheap Tool for Interest-Rate Worriers

At 20 basis points, iShares Floating Rate Bond Fund ETF is the cheapest way to get exposure to investment-grade floating-rate bonds, which can help hedge against rising interest rates.

Thomas Boccellari: Investors who are worried about short-term interest rates increasing may consider iShares Floating Rate Bond ETF (FLOT)--a passively managed ETF that buys investment-grade floating-rate bonds. Issuers include U.S. agencies--such as Fannie Mae and Freddie Mac--financial institutions, and other high-quality issuers.

Traditional bond funds generally invest in fixed-rate bonds. This becomes troublesome in a rising-rate environment because of the inverse relationship between bond prices and interest rates. So, if interest rates are rising, your income level remains the same; however, prices adjust down, which can increase your principal loss.

Floating-rate bonds, however, adjust on a quarterly basis. This means that in the same rising-rate environment, your income level increases and your principal level actually remains the same. So, your income increases and you don’t have principal losses compared with fixed-rate short-term bond ETFs.

When compared with other floating-rate bonds like bank loans and bank-loan ETFs, they generally have a floor on the interest-rate level. So, that means as interest rates start to increase from these all-time lows, investors won’t get that benefit until the interest rate increases above 1%. This fund does not have that problem. So, investors will get that benefit right away.

At 20 basis points, this is the cheapest way to get exposure to floating-rate bonds and a great way to hedge against rising interest rates.

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