Money managers and consultants are encouraged by the possibility that the U.S. Treasury Department will implement a floating-rate note program, the first new U.S. government debt security since TIPS were introduced in 1997.
The securities will “probably offer some value,” said Bret Barker, managing director, U.S. fixed income, at TCW Group, Los Angeles. But he's waiting for more information on the structure of the notes before knowing how much value the securities will offer.
Eric Knutzen, chief investment officer of Cambridge, Mass.-based investment consultant NEPC LLC., said: “I think it is an appropriate and probably important innovation for the Treasury to create this new type of security and I think there will be pretty good interest and reception in the institutional investment area and probably the retail as well.”
Robert Tipp, chief investment strategist at Boston-based Prudential Fixed Income, said investors are looking for a high-quality instrument where they can be relatively protected from an increase in interest rates.
“We'll stay in low interest rates for a while and interest rates are (eventually) going to go up and this creates a fear factor among investors,” said Mr. Tipp. “This (floating-rate notes) idea has been gestating for a while and I think it meets a confluence of factors that's creating what's likely a high demand for this type of security.”
Many fixed-income managers contacted for this story declined comment, saying that while the securities appeared interesting, more details were needed on how they would be structured.
The program, which the Treasury's borrowing advisory committee unanimously approved on Aug. 1, will take effect at least a year from now and will “complement the existing suite of securities issued and to support our broader debt-management objectives,” according to the minutes of the committee meeting.
The Treasury committee did not offer a timeline on deciding the notes' structure, but did say there was a discussion at the meeting on which floating-rate index should be used.
The committee “gravitated toward referencing treasury general collateral, in lieu of federal funds effective and T-bills,” according to meeting minutes. No agreement was reached.
In a presentation to the committee in February 2011, the Office of Debt Management stated that “institutional demand for such instruments would be strong based on the likely increase in holdings of short-term, high-quality assets required by Basel III,” and because “there is a dearth of default risk-free floating-rate assets.”
Stated Arman Gevorgyan, Darien, Conn.-based vice president, investment research, at Segal Rogerscasey: “The program adds to the tool kit of investors who target very safe instruments with no duration risk. (Floating-rate notes) also provide a hedge against a sudden and unexpected rise in short-term rates.
“Using FRNs will enable the Treasury to reduce its reliance on Treasury bills, which have to be rolled over periodically. Since FRNs will have longer maturities, they will likely carry higher yields than T-bills, which is … (a) point of attraction for investors,” he wrote in an e-mail.
Julia Vail, spokeswoman for North Carolina State Treasurer Janet Cowell, wrote in an e-mail: “The issuance of floating-rate notes could give the U.S. Treasury a broader investment base, since investors who are seeking protection from a rising rate environment may find the floating-rate structure more attractive.”
But she also noted: “With issuance not expected for another year, there are still a number of details to be worked out before the department could determine its level of interest.” Ms. Cowell is sole trustee of the $71.8 billion North Carolina Retirement Systems, Raleigh.
Pension funds will have “asset managers working for them that will probably find (floating-rate notes) them very useful in a number of contexts,” Mr. Knutzen said. “One of the challenges that institutional investors face is building exposures in their programs that will respond well in different economic environments.”
Among the different types of investing challenges floating-rate notes address is providing a “haven during flight-to-safety times when current Treasury offerings are at such a low interest rate.”
However, use by the institutional market will take some time, according to Mr. Knutzen.
“An example is in the (Treasury inflation-protected securities) market,” he said. “TIPS were seen as a very positive innovation, (but) it took a while until you had enough of a marketplace to build diversified portfolios.
“I think the TIPS experience will show that this will start small and will grow over time until eventually we may say it's almost amazing that we didn't have this (before).”