Floating Rate Funds Provide Hedge Against Rising Rates

U.S. Treasury yields are at record lows with no relief in sight, causing financial advisors to search for new sources of yield. One popular alternative strategy has been “floating rate” funds that invest in short-term bank loans made to leveraged companies. These floating rate bank loans are reset frequently––typically every three months or less. Their short duration and variable rates that “float” when market conditions change can help protect against rising interest rates.

And from an income perspective, the collective group of bank loan mutual funds tracked by Morningstar Inc. sports an appealing current SEC yield of 4.5 percent (as of January 31).

That said, there are obvious risks associated with lending to highly leveraged companies.  Bank loans have little interest rate risk, but they do have credit risk.  Most companies seeking bank loans are below investment grade.

These funds are something that would do well in a growing economy with a rising inflation rate.  A  healthy economy helps these companies increase sales and cash flow, while the reset in interest rates helps protect against rising inflation.

But bank loan funds can incur losses during rough patches for the economy and the stock market.

There are an ever-growing number of funds in the bank loan space. Morningstar tracks 41 mutual funds in this sector, and three new funds launched in the fourth quarter alone, including one from DoubleLine. There are also two exchange-traded funds focused on bank loan exposure––the PowerShares Senior Loan Port (BKLN) and the Highland/iBoxx Senior Loan ETF (SNLN).

Two mutual names in the group are Fidelity Floating Rate Hi Income fund (FFRHX) and the Eaton Vance Floating Rate fund (EABLX).  These are more conservatively positioned bank loans funds where you give up some upside potential in order to have superior downside protection.

But be mindful of the credit risk of these products and not view them as a substitute for money market funds.

Source:  Nathan Greenwald, Financial Advisor magazine


BKLN is a component of the D2 Capital Management Multi-Asset Income Portfolio and EABLX is a component of many D2 Capital Management fixed income portfolios.

The information contained in this article does not constitute a recommendation, solicitation, or offer by D2 Capital Management, LLC or its affiliates to buy or sell any securities, futures, options or other financial instruments or provide any investment advice or service. D2, its clients, and its employees may or may not own any of the securities (or their derivatives) mentioned in this article.

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