Floating Rate Funds: How Appropriate Are They?

by | Sep 2, 2014 | Asset Management, Videos

How familiar are you with bank loan funds? Maybe you’ve heard of floating rate funds? For the record, most bank loan funds are floating rate funds. They’re becoming popular due to the interest rate environment we’re experiencing. Many people feel interest rates will rise. With a floating rate fund, when interest rates rise their rates rise too. Most bonds aren’t capable of this. However, how appropriate are floating rate funds for the average bond investor?

Recently a chief strategist for a major investment firm was asked on Bloomberg radio to, “Tell us why bank loan funds – also called floating rate funds – are better than plain old corporate bonds?”. His response was the classic, jargon-laden statement you should expect if you’re a daily listener of any financial media program. He said that, “Bank loans are sub-investment grade assets, but they are senior to other debt instruments with better recovery rates”. Sounds crystal clear to us at Mullooly Asset Management, but how about the average investor?

We’ll provide a translation of that statement regarding floating rate funds:

“Bank loans are sub-investment grade assets” = They are junk
“But they are senior to other debt instruments” = They stand in line ahead of other bonds during a bankruptcy or liquidation
“With better recovery rates” = Sounds like they’ve had to go down the bankruptcy/liquidation road before

Most folks who invest in bonds are looking for income and some degree of safety. We want investors to be aware that if that’s what they’re looking for, floating rate funds are probably not for them. Floating rate funds are risky to say the least.

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