This may be a good time to move some money from cash and short-term bonds into floating-rate bank loans. By doing so, you may well boost your income and hedge against potential losses in your bond portfolio should interest rates climb in the coming year.
After returning essentially nothing over 2014 and 2015, floating-rate bank loans are having a banner 2016. In the first nine months of the year, a Standard & Poor’s index of the 100 largest floating-rate bank loans gained 8.5%, and the average bank loan mutual fund returned 7.1%. Current yields for bank loan mutual funds range from 3% to 5%.
Floating-rate loans are typically made to borrowers with low credit ratings. Although the loans are called floating-rate, the interest rate that borrowers pay banks doesn’t adjust daily. Rather, rates typically change every 90 days, but not until market rates exceed a certain floor. So it’s possible that the next Federal Reserve rate hike, which many analysts expect to come in December, may not result in higher rates for borrowers with floating-rate loans.
Sign up for Kiplinger’s Free E-Newsletters
Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.
Profit and prosper with the best of expert advice - straight to your e-mail.
Whether or not borrowing charges adjust upward soon, the bank loan market is benefiting from signs that things are improving for U.S. consumers. That matters because many floating-rate loans are made to retailers, casinos, cruise lines, hotel chains and other businesses whose fortunes depend on Americans spending freely. And because borrowers usually have subpar balance sheets, bank loans tend to perform poorly during periods of economic stress. For example, in 2008, in the depths of the financial crisis, the average bank loan mutual fund tumbled by nearly 30%.
There are few no-load bank loan mutual funds. My longtime favorite is Fidelity Floating Rate High Income Fund (symbol FFRHX, yield 4.1%). It is the oldest and largest no-load bank loan fund and charges below-average annual fees of 0.70%. The fund has been a reliable place to keep money since 2008 (a 16.5% loss that year put it in the top 1% of its category). Fidelity Floating Rate lost 1.2% in 2015 and gained 7.9% in 2016 through September 30. The only other no-load fund I’d consider is T. Rowe Price Floating Rate Fund (PRFRX, 4.0%). The fund, which charges 0.82% for expenses, gained 1.2% last year and 6.0% in the first nine months of 2016.
For fans of exchange-traded funds, the most seasoned choice is PowerShares Senior Loan Portfolio (BKLN, price $23, 4.6%). The fund, a member of the Kiplinger ETF 20, lost 3.1% last year and returned 7.4% in the first nine months of 2016. Its expense ratio is 0.65%.
Then there are the 37 closed-end funds that specialize in floating-rate loans. But closed-ends, which, like ETFs, trade on exchanges, are much more complex than their cousins. Share prices of ETFs tend to closely track the value of their underlying assets, but prices of closed-end funds can vary widely from their net asset value (NAV) per share. Moreover, all of the closed-end bank loan funds borrow money—up to 35% of their assets—to boost payouts. The use of leverage adds too much price risk for me to call these closed-ends a substitute for cash. That said, most are selling for wide discounts to their NAVs. For instance, Voya Prime Rate Trust (PPR, $5, 6.0%), the oldest bank loan closed-end fund, traded at an 8% discount to its NAV on September 30.
Putting aside the structure of the funds, in the end they are more alike than different. The same names crop up on lists of holdings whether you’re looking at a fund sponsored by Fidelity, T. Rowe Price, BlackRock or Nuveen. Figure on lending your money (indirectly) to Albertsons supermarkets, Caesars casinos, Hilton hotels and a handful of technology companies. The important task is to choose a fund with hundreds of positions, in case any of them default. Fidelity Floating Rate and the PowerShares ETF both easily qualify.
-
Here's How To Get Organized And Work For YourselfWhether you’re looking for a side gig or planning to start your own business, it has never been easier to strike out on your own. Here is our guide to navigating working for yourself.
-
How to Manage Risk With Diversification"Don't put all your eggs in one basket" means different things to different investors. Here's how to manage your risk with portfolio diversification.
-
Fed Sees Fewer Rate Cuts in 2025: What the Experts Are SayingFederal Reserve The Federal Reserve cut interest rates as expected, but the future path of borrowing costs became more opaque.
-
CPI Report Casts Doubt on Rate Cuts in 2025: What the Experts Are Saying About InflationCPI November Consumer Price Index data sealed the deal for a December rate cut, but the outlook for next year is less certain.
-
Rebound in Jobs Growth Keeps Fed on Track: What the Experts Are SayingJobs Report No nasty surprises in the November payrolls data leaves a quarter-point cut in play.
-
October CPI Report Hits the Mark: What the Experts Are Saying About Inflation
CPI While the current pace of rising prices appears to have leveled off, the expected path of rate cuts has become less certain.
-
Fed Cuts Rates Again: What the Experts Are Saying
Federal Reserve The central bank continued to ease, but a new administration in Washington clouds the outlook for future policy moves.
-
Market Reaction to Election Results: What the Experts Are SayingJobs Report Election uncertainty has been removed from the list of investors' worries, helping equities soar.
-
Jobs Growth Stalls Amid Hurricanes and Strikes: What the Experts Are SayingJobs Report A dismal October payrolls print supports the case for a slow and steady pace of rate cuts.
-
CPI Report Points to Gradual Pace for Rate Cuts: What the Experts Are Saying
CPI Inflation surprised to the upside last month but the disinflation trend remains on track.
