How floating rates can offer interest rate protection

How floating rates can offer interest rate protection

How floating rates can offer interest rate protection

Concern at the interest-rate environment is behind the rise of actively managed ETFs as advisors re-examine fixed-income risk.

That’s the view of Steven Leong, director, head of Canada iShares Product at BlackRock Canada, who said that the increasing need to balance credit and duration risk mean it’s more natural for an advisor to outsource a lot of their fixed-income exposure to an active manager.

Leong said: “Decade upon decade of falling interest rates meant that they reached their natural limit in that they couldn’t go any lower and that caused a lot of clients in the advice space to relook at how they were getting fixed-income exposure.”

ETFs continue to increase in popularity and Leong said that, other than the more attention-grabbing rise of actively managed vehicles, the other major trend in the space is the use of ETFs as core pillars of a portfolio.

In terms of the impact of interest rate hikes, he added that ETFs provide all the building blocks for investors to strategize their portfolio.

He said: “As an example, we have products that really take very minimal interest-rate risks, for example we have a floating rate note product where the coupon or the interest payment on the bond resets every quarter and tracks the movement of interest rates.

“If rates go up, the point goes up, so you don’t have the same interest-rate risk you would on a fixed-coupon bond. We also have exposures or products like Canadian preferred shares – and certainly the rate reset part of the market tends to have a positive relationship to interest rates. Again, if interest rates rise, they go up.”

Leong is less enthused by the proliferation of smart beta talk in the industry, believing that product development around this factor-based approach has been so swift it risks putting the cart before the horse.

He said: “There has been a lot of product built in this space and I think we’d argue that the product has come to market before investors have necessarily adjusted their mindset to know how to use them.

“But we don’t see this as a trend; this is a permanent evolution in the way people think about their equity portfolios. So we see this stage as being at the very early stage of adoption of these types of strategies.”

 

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