When interest rates are as low as they are today, it is common for fixed-income investors to seek higher yields. One option to consider: mutual funds that hold floating-rate loans.
Floating-rate loans have “floating” interest rates, which simply means the rates are variable. The rates adjust periodically (usually every 30 to 90 days) based on changes in widely accepted reference rates, such as the London Inter-Bank Offered Rate, commonly referred to as LIBOR.
Floating-rate loans offer investors several potential benefits.
First, floating-rate loans offer a measure of protection from interest rate risk, which is the risk that your investments will yield less when interest rates are low. That is because floating-rate loans generally pay interest rates higher than many other fixed-income investments.
Second, floating-rate loans are typically well secured. They sit at the top of a company’s capital structure. This has led historically to higher recovery rates in the event of default.
Lastly, floating-rate loans may offer the potential for diversification: they have tended to have low correlations to other major asset classes.
That said, there are risks to investing in floating-rate loans, as there are with all investments. Because they generally invest in low-quality credit, floating-rate loans should be considered somewhat risky. Additionally, floating-rate funds may not have stable net asset values, which makes some investors uncomfortable.
If you think the pros outweigh the cons, however, some mutual funds buy floating-rate loans, thereby giving investors the opportunity to share in the potential earnings.
Contact us today if you are interested in floating-rate loans.