Fixed Income · 5 min read · 2026-02-01
The 9-variable floating-rate decision.
Floating-rate notes are the bond market's response to rising rate fears. Nine variables size the allocation correctly.
Floating-rate is the cure for duration risk and the cause of credit risk.
Floating-rate notes have near-zero interest-rate duration but full credit duration. They produce stable coupons in rising-rate regimes and meaningful drawdowns when credit conditions deteriorate.
The nine indicators
The nine variables of FRN allocation.
Each is a feature of the FRN structure or market environment. The composite produces the right exposure for the regime.
Rate cycle position (rising/falling/flat)
Pattern: FRN wins rising
Rising-rate regimes favor FRNs. Coupons reset upward. Falling-rate regimes favor fixed-rate bonds.
Credit quality of the FRN
Threshold: IG vs HY
Investment-grade FRN funds (FLOT) have lower credit risk. High-yield bank loans (BKLN) have meaningful credit drawdowns.
Reference rate (SOFR, LIBOR, prime)
Pattern: SOFR standard now
SOFR replaced LIBOR. The reference rate matters for understanding spread and reset behavior.
Reset frequency (monthly, quarterly)
Pattern: monthly preferred
More frequent resets track rates more closely. Monthly resets preferred over quarterly.
Spread over reference rate
Threshold: cycle-relative
Spreads compress in benign credit; widen in stress. Compare current spread to historical band.
Floor and cap provisions
Pattern: floor protects yield
Some FRNs have rate floors that protect yield in zero-rate environments. Floors add value in low-rate regimes.
Liquidity in stress
Pattern: ETF vs direct
FRN ETFs have ETF-level liquidity even when underlying loans become illiquid. The wrapper matters in stress.
Tax treatment
Pattern: ordinary income
FRN coupon income is ordinary-rate. Tax-advantaged placement matters.
Default cycle position
Pattern: late-cycle vulnerability
Late-cycle credit conditions raise FRN default risk. Position at peak earnings reduces; bad cycle position destroys.
What FRNs do
Floating-rate notes pay coupons that adjust with a reference rate (SOFR, prime, etc.) plus a spread. As rates rise, coupons rise. The structure has near-zero interest-rate duration — the bond's NAV doesn't change much when rates change because the coupon adjusts to compensate.
The trade-off is that FRNs carry full credit risk. The 'floating' refers to the rate, not the principal. When credit conditions deteriorate, FRN spreads widen and prices fall. The 2008 and 2020 cycles produced meaningful FRN drawdowns despite the rate-protection feature.
When FRNs win
FRNs win in rising-rate regimes. The 2022 rate-tightening cycle was favorable for FRNs — coupons reset upward as Fed funds rate rose, while traditional bonds suffered duration-driven losses of 10–20%. Investment-grade FRN ETFs (FLOT) produced stable returns through the cycle.
FRNs also fit specific portfolio gaps: short-duration income, alternative to cash with higher yield, hedge against unexpected rate increases. The role is targeted, not core fixed income.
When FRNs lose
Falling-rate regimes are unfavorable for FRNs. Coupons reset downward; the rate-protection feature stops mattering. Traditional duration-bearing bonds outperform via rate-driven price appreciation that FRNs cannot capture.
Credit-deterioration regimes are also unfavorable. Even investment-grade FRNs face spread widening; high-yield bank loan funds (BKLN, leveraged-loan ETFs) face credit-driven drawdowns that exceed their coupon advantage. Position sizing must account for this credit-cycle exposure.
Implementation choices
Investment-grade FRN exposure via FLOT (iShares Floating Rate Bond ETF). Bank loan exposure via BKLN (Invesco Senior Loan ETF) or actively-managed alternatives. Direct corporate FRN bonds for sophisticated holders.
For most retail, ETF exposure is sufficient. The FRN allocation typically runs 5–15% of fixed income, sized to the rate-regime view. Exceeding 25% of fixed income concentrates the credit-cycle risk inappropriately.
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Common questions
Questions.
Are FRNs the same as bank loans?
Bank loans are a subset — typically high-yield, senior-secured, floating-rate. Investment-grade FRNs (corporate FRNs from IG issuers) are different and lower-credit-risk.
What's a leveraged loan?
Bank loan made to highly-leveraged companies (private equity portfolios, etc.). Yields higher; defaults higher in credit stress.
Are FRNs tax-efficient?
No. Coupons are ordinary income. Tax-advantaged account placement is preferred.
What's the duration of FRNs?
Near zero on rate side, but credit-spread duration can be 2–5 years. The composite duration depends on credit cycle.
Should I avoid bank loan ETFs in recession?
Yes, often. BKLN drew down 30%+ in 2008 and 8% in 2020. The credit cycle dominates FRN performance in stress.
Are CLOs FRNs?
Collateralized loan obligations are pools of bank loans. The senior tranches behave like FRNs; equity tranches are equity-like.
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