What are Floating Rate Notes?

Floating Rate Notes (FRNs) are bonds whose coupon payments are linked to interest rates. Unlike traditional bonds, whose prices fall when interest rates rise, FRNs offer protection against rising interest rates as their coupons adjust upwards accordingly, effectively immunising them against interest-rate effects.

Why look at FRNs now?

Government interest rates have been falling steadily for the past 25 years. In 1990, the US 10-year bond yield was 8%, compared with 3% now. In Germany and Japan, 10-year bond yields are now at around 0%. No one is betting on another 25 years of falling interest rates.

The long-term outlook points to gradually increasing rates as economies continue to strengthen following the 2008 financial crisis, and this economic improvement exerts inflationary pressure – in turn pressing rates higher. In particular, developed market central banks are nearing the end of their emergency quantitative easing programmes, and are looking to scale back or unwind all of the asset purchases made over recent years.

The withdrawal of central bank intervention will help to remove distortions and return markets more towards pricing based on fundamentals – countries and companies with less healthy debt dynamics will be required to pay more (ie. investors demanding greater yields to compensate for the increased risk).

The withdrawal of central bank intervention will help to remove distortions and return markets more towards pricing based on fundamentals – countries and companies with less healthy debt dynamics will be required to pay more (ie. investors demanding greater yields to compensate for the increased risk).

Have FRNs protected investors against previous rate rises?

Yes. In the past few years we have experienced several violent rises in interest rates. During each episode, FRNs have outperformed traditional fixed bond indices, most easily illustrated when looking at the high yield bond universe. easing), global bond yields moved significantly higher. In 2016, yields were once again extremely volatile, rising steeply early in the year after fears around global growth fragility dissipated and risky assets recovered (sending safe-haven government yields higher). Later in the same year, yields surged again after the election of President Trump in the US drove expectations of higher inflation in the US economy.

Looking ahead...

Interest rates are expected to rise across major developed markets over the coming years – strategies that offer protection against rising rates provide the potential for investors to continue earning healthy returns from fixed income markets. Credit assets are expected to remain supported by positive macroeconomic conditions, as well as strong demand from a global investor base. Accessing credit risk premia through a floating-rate structure can provide investors with the ability to harvest additional income from credit allocations whilst also benefitting from rising interest rates. Active management of a global floating-rate credit strategy can also offer the added advantages of active risk management, in order to protect capital in times of stress, and dynamically manage allocations to different sectors and rating tiers, allowing a focus on maximizing expected returns when opportunities arise.

Investing involves risk. The value of an investment and the income from it may fall as well as rise and investors might not get back the full amount invested. Investing in fixed income instruments may expose investors to various risks, including but not limited to creditworthiness, interest rate, liquidity and restricted flexibility risks. Changes to the economic environment and market conditions may affect these risks, resulting in an adverse effect to the value of the investment. During periods of rising nominal interest rates, the values of fixed income instruments (including short positions with respect to fixed income instruments) are generally expected to decline. Conversely, during periods of declining interest rates, the values of these instruments are generally expected to rise. Liquidity risk may possibly delay or prevent account withdrawals or redemptions. Past performance is not a reliable indicator of future results. If the currency in which the past performance is displayed differs from the currency of the country in which the investor resides, then the investor should be aware that due to the exchange rate fluctuations the performance shown may be higher or lower if converted into the investor’s local currency.

The views and opinions expressed herein, which are subject to change without notice, are those of the issuer companies at the time of publication. The data used is derived from various sources, and assumed to be correct and reliable, but it has not been independently verified; its accuracy or completeness is not guaranteed and no liability is assumed for any direct or consequential losses arising from its use, unless caused by gross negligence or wilful misconduct. The conditions of any underlying offer or contract that may have been, or will be, made or concluded, shall prevail.

This is a marketing communication issued by Allianz Global Investors GmbH, www.allianzgi.com, an investment company with limited liability, incorporated in Germany, with its registered office at Bockenheimer Landstrasse 42-44, 60323 Frankfurt/M, registered with the local court Frankfurt/M under HRB 9340, authorised by Bundesanstalt für Finanzdienstleistungsaufsicht (www.bafin.de). Allianz Global Investors GmbH has established a branch in the United Kingdom, Allianz Global Investors GmbH, UK branch, 199 Bishopsgate, London, EC2M 3TY, www.allianzgi.co.uk, which is subject to limited regulation by the Financial Conduct Authority (www.fca.org.uk). Details about the extent of our regulation by the Financial Conduct Authority are available from us on request. The duplication, publication, or transmission of the contents, irrespective of the form, is not permitted; except for the case of explicit permission by Allianz Global Investors GmbH.