Van Kampen: Rate Sensitive Play
03/05/2004 12:00 am EST
"There are very few income securities that offer protection against a future rise in interest rates," says Gordon Pape. "Our latest featured investment is one of the exceptions." Here, the editor of the Income Investor explains the nature of this unusual closed-end fund.
"Van Kampen Senior Income Trust (VVR NYSE), a closed end fund, operated by Van Kampen Investments, a Chicago-based money management company with about $100 billion in assets under management. The Income Trust invests in a portfolio of senior collateralized loans to corporations with low credit ratings (or in some cases with no credit rating at all), usually with maturities of less than five years. The portfolio is broadly diversified (about 300 positions at any given time) so that default risk is minimized. Most of the loans held in the fund are variable or floating rate. This means that if US interest rates rise, the yields on the loans held by the fund will follow suit.
"The fund provides steady cash flow in the form of monthly distributions, which are currently being paid at the rate of about 40 cents a year for a cash-on-cash yield of 4.6% based on the market price. This is a big fund with almost $1.5 billion in assets. However, the asset base is down from $1.8 billion in 1999, which is a reflection of declining interest rates during that period. The fund is coming off a hugely successful year with a total return of almost 36% in 2003 (market price), due to the surge in the market value of corporate notes. That was likely a once-in-a-lifetime event and is unlikely to be repeated. However, there are still some capital gains potential here to go along with the decent cash flow.
"There are risks. The fund has what might be called reverse interest rate sensitivity. It actually lost money in its 2001 and 2002 fiscal years (ending July 31), when US interest rates were on the decline. However, it appears very unlikely that US rates will move down from this point. There is also default risk, arising from the nature of the portfolio. This higher risk security is suitable for investors who are looking for US dollar income, protection against rising interest rates, and modest capital gains potential. For our Canadian readers, we would note that the Van Kampen Senior Income Trust is a unique type of security with no counterpart in Canada. It is currently trading at a slight premium to its net asst value of $8.55, which suggests that the market believes it is likely to continue to rise in price."