With the current interest rate outlook in mind many Australian investors are seeking strategies that deliver reliable income while managing risk.

A key source of income may be accessed through exchange-traded funds (ETFs) that invest in floating rate bonds. These ETFs offer a compelling blend of income potential, capital stability, and flexibility-making them an attractive option for retirees and income-focused portfolios.

What Are Floating Rate ETFs?

Floating rate bonds or "notes" are investments in bonds whose interest payments adjust periodically based on prevailing short-term rates. Unlike fixed-rate bonds, which lock in an interest rate coupon (i.e. payment) for the life of the security, floating rate instruments reset their rates-typically quarterly-according to benchmarks such as the Bank Bill Swap Rate (BBSW). This feature significantly reduces interest rate risk and positions these ETFs as a defensive income play when rates are rising.

Why Consider Them Now?

Over the past few years, Australia has experienced a cycle of rate hikes. While we have seen the RBA reduce rates by 0.50% during 2025, future movements remain uncertain and floating rate ETFs provide a natural hedge. When interest rates increase, the income from these ETFs generally rises, helping investors maintain purchasing power. Conversely, if rates fall, income may decline, but the capital value tends to remain more stable compared to traditional fixed-rate bonds.

Income Potential and Key Benefits

Investment-grade floating rate ETFs, such as the VanEck Australian Floating Rate Bond ETF (ASX: FLOT) and BetaShares Australian Bank Senior Floating Rate Bond ETF (ASX: QPON), focus on high-quality issuers-primarily major Australian banks and top-rated corporates. These funds typically offer:

• Attractive Running Yields: Current yields hover around 4.5%-5.5%, paid monthly or quarterly, often exceeding returns on cash or short-term deposits.
• Capital Stability: Senior bank-issued floating rate bonds have historically shown low volatility and strong defensive characteristics during equity market downturns.
• Liquidity: ETFs trade on the ASX, allowing investors to buy or sell quickly, unlike term deposits that require notice periods and may incur penalties for early withdrawal.
• Diversification: Exposure to a broad portfolio of bonds reduces issuer-specific risk compared to holding individual securities.

Strategic Role in Portfolios

For retirees and pre-retirees, floating rate ETFs can serve as a cornerstone of an income strategy. They complement term deposits and fixed-rate bonds by adding flexibility and mitigating duration risk. While these ETFs are not risk-free-credit risk and market liquidity considerations remain-they generally carry lower risk than shares and offer higher income than cash.

How Do They Compare to Term Deposits and Fixed-Rate Bonds?

• Term Deposits: Offer guaranteed returns and capital security but lock investors into fixed rates for the term. In a rising rate environment, this can mean missing out on higher yields. Floating rate ETFs, by contrast, adjust income as rates move, providing more flexibility.
• Fixed-Rate Bonds: Provide predictable income but carry significant interest rate risk - prices fall when rates rise. Floating rate ETFs mitigate this risk because their coupon payments reset, helping preserve capital value.
• Liquidity Advantage: ETFs can be traded daily on the ASX, whereas term deposits and many bonds require waiting until maturity or incurring break costs.

Points to Keep in Mind

• Brokerage costs apply when buying or selling ETFs.
• Income will fluctuate with interest rates changes more quickly than fixed-rate bonds.
• Unlike term deposits, bond ETFs will still fluctuate in value, although this is significantly less than shares.
• Always review the Product Disclosure Statement (PDS) and consider how these ETFs fit within your broader financial plan.

Bottom Line: Investment-grade floating rate bond ETFs provide a practical way to generate income while managing interest rate risk. For Australian investors seeking stability and yield in a changing market, these ETFs offer attractive income, often paid monthly, as part of a diversified portfolio.