Home > Articles > Business & Management > Finance & Investing

  • Print
  • + Share This
This chapter is from the book

Floating Rate Bank Loan Funds—A Special Kind of High-Yield Investment

  • "When in doubt, punt."
  • John Heisman

Floating rate bank loan funds are relatively new members of the retail mutual fund universe, but they have proven themselves to be excellent tools during periods of unstable interest rates. In the current environment of low interest rates that is prevailing (April 2007), the 6.5%–7.5% available from floating rate funds is very attractive. Table 7.1 lists the yields available from different types of bond investments, as well as the relative levels of historical risk.

Table 7.1. Recent Yields to Maturity and Historical Price Risks for Different Types of Bond Investments

Type of Bond Investment

Current Yield (Yield to Maturity)

Relative Historical Risk

3-month Treasury bill

5.0%

None

10-year Treasury note

4.65%

Moderate

Investment-grade bonds overall (iShares Lehman Aggregate Bond Index ETF ticker symbol AGG)

5.2%

Low-moderate

High yield bond fund

6.6%4

Moderate-high

Floating rate bank loan fund

7.0%

Moderate

If you have ever taken out a mortgage, you have probably noticed that every couple of years you have to write down a new address to which you mail your payments or address your inquiries. This occurs because the bank or investor that had originally lent you the money for your house decided to sell your loan to another institution, just as you might sell a bond that you hold in a brokerage account. There is a similar, but much smaller niche in the bond market involving bonds backed by adjustable-rate loans that banks have made to businesses. It is in this relatively obscure corner of the bond market that one of the best-yielding, moderate-risk bond investments is found.

There are 29 distinct5 floating rate bank loan funds offered by 20 different mutual fund families. Of these, nearly half (14 of 29) were incorporated in 2002 or later, meaning that there is far less history for these types of funds than for most other types of stock or bond funds of interest to you as individual investors. The good news is that the earliest retail bank loan funds were launched in 1989, which gives us some glimpse into the pitfalls that might occur in the future.

The interest rates on the loans in which floating rate loans invest are adjustable, so there is no interest rate risk as there would be with a regular bond. In fact, if interest rates rise, you are better off because that will increase the amount of interest income paid to you as dividends. Moreover, adjustable interest rates tend to rise when inflation does, so this investment will probably not expose you to as much inflation risk as does a fixed-rate bond.

Credit risk is the main risk involved with floating rate bank loan funds. There is no guarantee that a corporate borrower will pay all the principal and interest due on a loan, nor that the collateral will be sufficient to cover its obligations. Earlier we mentioned high yield bond mutual funds—funds that hold bonds that have credit ratings below investment grade. The debt that bank loan funds hold tends to be from companies whose credit ratings are similar to those of high yield bond issuers. However, bank loans are generally better backed by collateral than high yield bonds are. As a result, when companies have defaulted on their debt obligations, holders of bank loan debt have fared better than holders of high yield bonds. (Generally, floating rate bank loan funds have at least 80% of their holdings in senior, secured debt. Senior debt is the first to get repaid in the event of a default, and "secured" means that there is specific collateral pledged to the repayment of the particular loan.)

Floating rate bank loan funds pay generous rates of interest compared to investment-grade bond funds precisely because of the credit risk. For example, as of early November 2007, floating rate funds are paying 6.5%–7.5% per year, which is 1–2%/year above what the typical investment-grade bond pays. In fact, yields are currently similar to what you can get from high yield bond funds, even though the latter have had significantly greater risk.

Floating rate funds vary widely with respect to the amount of risk they have experienced. The worst periods for floating rate funds occurred during the second half of 2002 and again in mid-2007. In 2002, the peak-to-valley losses in the value of floating rate funds ranged from 2% to 7%. From June-September 2007, losses in floating rate funds are ranging from 2%–4% but could extend further. Although there is no guarantee that future losses will not be more severe at some point in the future, 2002 was a period of low confidence in business, in which every type of corporate bond investment was punished for the sins of the stock market in general, and for corporate malefactors (such as Enron) in particular. The fact that a number of floating rate funds were able to weather that storm with only modest losses gives us some confidence in that sector.

There is one additional risk that these funds' price histories do not reveal. Unlike the case for mortgage-backed bonds, the market for bank loans is not very active. If one of these funds were to be hit with a wave of simultaneous shareholder redemptions, it could be very difficult for the fund manager to raise the necessary cash. As a result, bank-loan funds have various rules in place to protect them (and the funds' other shareholders) from the consequences of massive redemptions. Specifically, bank-loan funds require you to hold them for a minimum period, typically three months. In addition, many limit redemptions to specific dates of each month or quarter.

Lastly, bank-loan funds reserve the right to limit the total percentage of outstanding shares they will redeem at any one time. If more shareholders want to redeem than the fund allows, each shareholder gets only a pro-rata share of their request. For example, the Oppenheimer Senior Income Fund limits redemptions to between 5% and 25% of outstanding shares each quarter. The fund gives notice a few weeks in advance of how many shares they are prepared to redeem, and requires advance notice from shareholders as to how much they want redeemed. If the fund announced a willingness to redeem 5% of outstanding shares, but shareholders tendered 15% of shares for redemption, then each shareholder would get out of only one-third of his shares. Details are in the prospectus for this fund.6 During the summer of 2007, some floating rate funds did receive more requests for redemptions than they were prepared to honor, so shareholders were not able to access their cash.

During periods of stable or rising interest rates, floating rate funds are excellent candidates for part of your portfolio. Table 7.2 lists some of our favorite floating rate funds.

Table 7.2. Selected Floating Rate Funds with Current Yields as of March 2007

Fund Name

Ticker Symbol

Current Yield

Comment

Oppenheimer Senior Floating Rate

XOSAX

7.0%

Can only redeem on one specific date every three months.

Hartford Floating Rate

HFLIX7

6.5%

ING Senior Income

XSIAX

6.5%

Can only redeem from this fund on the tenth business day of each month.

Highland Floating Rate

XLFAX

7.2%

Can only redeem on one specific date every three months.

As with any mutual fund, you should not pay an upfront or deferred sales charge in order to purchase these. Rather, utilize a discount brokerage house where these shares are available without sales charges (although modest transaction charges may be involved).

Which brings us back to the quote by John Heisman at the beginning of this section.... If you are uncertain about the market climate but want to earn potentially more than you could in a money market or bank CD, floating rate funds are a way to go. However, the restrictions on redeeming your assets from these funds once you invest renders these unsuitable for money to which you might need ready access on short notice.

  • + Share This
  • 🔖 Save To Your Account

InformIT Promotional Mailings & Special Offers

I would like to receive exclusive offers and hear about products from InformIT and its family of brands. I can unsubscribe at any time.

Overview


Pearson Education, Inc., 221 River Street, Hoboken, New Jersey 07030, (Pearson) presents this site to provide information about products and services that can be purchased through this site.

This privacy notice provides an overview of our commitment to privacy and describes how we collect, protect, use and share personal information collected through this site. Please note that other Pearson websites and online products and services have their own separate privacy policies.

Collection and Use of Information


To conduct business and deliver products and services, Pearson collects and uses personal information in several ways in connection with this site, including:

Questions and Inquiries

For inquiries and questions, we collect the inquiry or question, together with name, contact details (email address, phone number and mailing address) and any other additional information voluntarily submitted to us through a Contact Us form or an email. We use this information to address the inquiry and respond to the question.

Online Store

For orders and purchases placed through our online store on this site, we collect order details, name, institution name and address (if applicable), email address, phone number, shipping and billing addresses, credit/debit card information, shipping options and any instructions. We use this information to complete transactions, fulfill orders, communicate with individuals placing orders or visiting the online store, and for related purposes.

Surveys

Pearson may offer opportunities to provide feedback or participate in surveys, including surveys evaluating Pearson products, services or sites. Participation is voluntary. Pearson collects information requested in the survey questions and uses the information to evaluate, support, maintain and improve products, services or sites, develop new products and services, conduct educational research and for other purposes specified in the survey.

Contests and Drawings

Occasionally, we may sponsor a contest or drawing. Participation is optional. Pearson collects name, contact information and other information specified on the entry form for the contest or drawing to conduct the contest or drawing. Pearson may collect additional personal information from the winners of a contest or drawing in order to award the prize and for tax reporting purposes, as required by law.

Newsletters

If you have elected to receive email newsletters or promotional mailings and special offers but want to unsubscribe, simply email information@informit.com.

Service Announcements

On rare occasions it is necessary to send out a strictly service related announcement. For instance, if our service is temporarily suspended for maintenance we might send users an email. Generally, users may not opt-out of these communications, though they can deactivate their account information. However, these communications are not promotional in nature.

Customer Service

We communicate with users on a regular basis to provide requested services and in regard to issues relating to their account we reply via email or phone in accordance with the users' wishes when a user submits their information through our Contact Us form.

Other Collection and Use of Information


Application and System Logs

Pearson automatically collects log data to help ensure the delivery, availability and security of this site. Log data may include technical information about how a user or visitor connected to this site, such as browser type, type of computer/device, operating system, internet service provider and IP address. We use this information for support purposes and to monitor the health of the site, identify problems, improve service, detect unauthorized access and fraudulent activity, prevent and respond to security incidents and appropriately scale computing resources.

Web Analytics

Pearson may use third party web trend analytical services, including Google Analytics, to collect visitor information, such as IP addresses, browser types, referring pages, pages visited and time spent on a particular site. While these analytical services collect and report information on an anonymous basis, they may use cookies to gather web trend information. The information gathered may enable Pearson (but not the third party web trend services) to link information with application and system log data. Pearson uses this information for system administration and to identify problems, improve service, detect unauthorized access and fraudulent activity, prevent and respond to security incidents, appropriately scale computing resources and otherwise support and deliver this site and its services.

Cookies and Related Technologies

This site uses cookies and similar technologies to personalize content, measure traffic patterns, control security, track use and access of information on this site, and provide interest-based messages and advertising. Users can manage and block the use of cookies through their browser. Disabling or blocking certain cookies may limit the functionality of this site.

Do Not Track

This site currently does not respond to Do Not Track signals.

Security


Pearson uses appropriate physical, administrative and technical security measures to protect personal information from unauthorized access, use and disclosure.

Children


This site is not directed to children under the age of 13.

Marketing


Pearson may send or direct marketing communications to users, provided that

  • Pearson will not use personal information collected or processed as a K-12 school service provider for the purpose of directed or targeted advertising.
  • Such marketing is consistent with applicable law and Pearson's legal obligations.
  • Pearson will not knowingly direct or send marketing communications to an individual who has expressed a preference not to receive marketing.
  • Where required by applicable law, express or implied consent to marketing exists and has not been withdrawn.

Pearson may provide personal information to a third party service provider on a restricted basis to provide marketing solely on behalf of Pearson or an affiliate or customer for whom Pearson is a service provider. Marketing preferences may be changed at any time.

Correcting/Updating Personal Information


If a user's personally identifiable information changes (such as your postal address or email address), we provide a way to correct or update that user's personal data provided to us. This can be done on the Account page. If a user no longer desires our service and desires to delete his or her account, please contact us at customer-service@informit.com and we will process the deletion of a user's account.

Choice/Opt-out


Users can always make an informed choice as to whether they should proceed with certain services offered by InformIT. If you choose to remove yourself from our mailing list(s) simply visit the following page and uncheck any communication you no longer want to receive: www.informit.com/u.aspx.

Sale of Personal Information


Pearson does not rent or sell personal information in exchange for any payment of money.

While Pearson does not sell personal information, as defined in Nevada law, Nevada residents may email a request for no sale of their personal information to NevadaDesignatedRequest@pearson.com.

Supplemental Privacy Statement for California Residents


California residents should read our Supplemental privacy statement for California residents in conjunction with this Privacy Notice. The Supplemental privacy statement for California residents explains Pearson's commitment to comply with California law and applies to personal information of California residents collected in connection with this site and the Services.

Sharing and Disclosure


Pearson may disclose personal information, as follows:

  • As required by law.
  • With the consent of the individual (or their parent, if the individual is a minor)
  • In response to a subpoena, court order or legal process, to the extent permitted or required by law
  • To protect the security and safety of individuals, data, assets and systems, consistent with applicable law
  • In connection the sale, joint venture or other transfer of some or all of its company or assets, subject to the provisions of this Privacy Notice
  • To investigate or address actual or suspected fraud or other illegal activities
  • To exercise its legal rights, including enforcement of the Terms of Use for this site or another contract
  • To affiliated Pearson companies and other companies and organizations who perform work for Pearson and are obligated to protect the privacy of personal information consistent with this Privacy Notice
  • To a school, organization, company or government agency, where Pearson collects or processes the personal information in a school setting or on behalf of such organization, company or government agency.

Links


This web site contains links to other sites. Please be aware that we are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of each and every web site that collects Personal Information. This privacy statement applies solely to information collected by this web site.

Requests and Contact


Please contact us about this Privacy Notice or if you have any requests or questions relating to the privacy of your personal information.

Changes to this Privacy Notice


We may revise this Privacy Notice through an updated posting. We will identify the effective date of the revision in the posting. Often, updates are made to provide greater clarity or to comply with changes in regulatory requirements. If the updates involve material changes to the collection, protection, use or disclosure of Personal Information, Pearson will provide notice of the change through a conspicuous notice on this site or other appropriate way. Continued use of the site after the effective date of a posted revision evidences acceptance. Please contact us if you have questions or concerns about the Privacy Notice or any objection to any revisions.

Last Update: November 17, 2020