Fond of Floating Rates

08/16/2016 9:00 am EST

Focus: FUNDS

David Fabian

Managing Partner, FMD Capital Management

One of the benefits of our portfolio strategy is the flexibility to use closed-end funds instead of staying strictly within the confines of exchange-traded funds, states David Fabian, editor of Flexible Growth and Income Report.

In our opinion, we have a unique opportunity to capitalize on senior loans through a much more effective vehicle.

The reason we are not recommending our subscribers to simply buy the Powershares Bank Loan ETF (BKLN) is because the ETF has presented liquidity constraints in the past, which would be one of the few reasons to go with an ETF over a closed-end fund (CEF) in the first place.

Furthermore, the BKLN doesn’t have an ultra-low expense ratio that would entice us to purchase the fund over the long-term.

Which is why we are now recommending the purchase of a 5% position in the Blackrock Floating Rate Income Strategies Fund (FRA).

We will initially rate this new holding as a tactical position with the potential to be shifted as necessary given market and risk conditions.

We decided on this particular fund because we find the expenses, size, discount characteristics and portfolio composition to align with our needs at this juncture.

Furthermore, we won’t hesitate to add to the position if we believe the aforementioned factors begin to add value and/or our thesis on loans begins to build momentum.

The loan space is fraught with credit pitfalls, where even a basic analysis could yield an intermingling of securities with the potential to outperform a passive index.

Furthermore, the unique wrapper of a CEF allows for the use of leverage and increased distribution yield relative to an ETF.

At the current low leverage borrowing costs, leverage terms almost mirror most bank loan terms, so that even if borrowing costs were to rise over time, bank loan yields would rise commensurately.

This allows us to capitalize on leverage without the risk of fixed-coupon and leverage-borrowing cost spread compression, which can place a performance burden on a standard high yield CEF.

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By David Fabian, Editor of Flexible Growth and Income Report

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