TFLO Went From Being A Money Dump To An Active Play (NYSEARCA:TFLO)

The iShares Treasury Floating Rate Bond ETF (NYSEARCA:TFLO) used to be a money dump for any standby funds that you might have between equity ideas. That was before the prospect of formidable rates had come, and could compete with rising costs of capital and risks that are more pronounced in the equity world. Now TFLO makes sense as an active play where long-term inflation is a risk, and interest rates may need to stay high. When markets freak out on the prospect that there’s nowhere to hide in equity markets once interest rates that are risk free approach 6%, TFLO will have been a great active pick.

What TFLO Does For Your Stock Account

TFLO is a very low cost ETF that gives you 3.2% YTM, or rather 3.05% net of fees. This return is as of today, because the rates are floating. While you’re likely to pay a little premium for the benefit of avoiding duration risk, it’s a premium well paid in the current market where duration is overvalued.

The TFLO is a decent place to put standby cash, of which there is likely a fair bit given how investors have been pouring out of equity markets. Equity markets, especially in the US, are rather overvalued. In a recession you shouldn’t expect earnings growth, so earnings yield is a decent benchmark of required returns on markets. The US market has a required return of barely over 4%. The 1Y treasury rate is at that level now, which means you get no premium for equity risk. The premium on 10Y rates which are little more in touch with equity horizons are not much better. In Europe, you get 10% earnings yield, which probably still isn’t enough but is close.

Besides the benefit of not being an equity exposure, there is an inflation play here too. Simply put, inflation is like fire and it can propagate. When it comes from cost push factors, it’s like a fire on top of a gas reservoir, and can’t easily be put out. Higher rates might bring it down to manageable levels, but those rates may very well have to stay high to keep inflation reasonable. That could mean we’re building to higher rates more permanently and jumping the gun with new long duration issues might still be a bad idea. Not locking in current rates should get you to still high returns, perhaps around 6%, pretty quickly, which is likely where rates are going. If inflation peaks and money pours back into equity markets, you don’t get particularly punished for having variable rate securities, except for the opportunity cost of not speculating on the fortunes of equity markets. With geopolitical evolutions very unclear around Ukraine, which could become an existential undertaking for the Russian autocrats with nukes, we wouldn’t get too excited about equities, especially equities broadly. Not speculating on out of control coin flips is pretty sound advice.

Remarks

The outcome of a well thought analysis in current markets can only be one thing really, which is that it is an above-average uncertain market to put it mildly. If that’s the conclusion, the bet is low credit risk, no duration risk, floating credit instruments where the source of the uncertainty is the somewhat more certain commitment to raise rates, being the only tool anyone has left to deal with one of the big sources of today’s uncertainty and complications: inflation. TFLO is a buy.

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