Floating Rate Funds: Set to Rise?

03/21/2016 10:00 am EST

Focus: FUNDS

Mark Salzinger

Editor and Publisher, The No-Load Fund Investor

The high yield market is being hurt by the carnage that has been taking place in the energy and materials sectors over the past year, observes Mark Salzinger, editor of No-Load Fund Investor.

In turn, this has hurt the market for floating rate bank loans, even though energy makes up only 3% of the market for floating rate loans.

Floating rate loans comprise loans issued by banks usually to below investment grade companies.

Mostly collateralized by physical assets of the borrower, these loans are normally senior in the credit hierarchy to regular high-yield debt.

As a result, they are considered to be higher in credit quality than high yield bonds from the same companies.

Also, their interest rates are set as spreads against very short-term rates, against which they adjust over time with just a small lag.

Therefore, they have almost no interest rate risk, and can provide effective diversification against conventional fixed income products during periods of rising short-term rates.

In other words, there has been a kind of technical downturn in the market for floating rate loans, not a downturn based on fundamentals of the borrowers.

As a result, yields have increased in the asset class to the point where we believe they provide an attractive opportunity for income investors.

We include two floating rate bond funds in “Best Buys” portfolio: Price Floating Rate (PRFRX) and Fidelity Floating Rate High Income (FFRHX).

Price Floating Rate currently offers an SEC yield of 4.3%, vs. 5.5% for the Fidelity Floating Rate fund.

However, the Price offering has been performing better. Over the past 12 months, PRFRX is down 1.0%, vs. a loss of 4.3% in FFRHX.

However, we expect the next 12 months to be better for these funds than the past 12 have been.

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By Mark Salzinger, Editor of No-Load Fund Investor

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