INCLINE VILLAGE, Nev. — In mid-February I wrote about bank loan funds and listed the ones I was buying for client accounts. I wasn’t the only one who considered them as attractive. This year investors have poured nearly $2 billion into PowerShares Senior Loan Portfolio (BKLN), the largest bank loan ETF.
Bank loan funds, also called floating rate funds, invest in loans made by banks to corporations, most of which are rated below investment grade. Because the loans “float,” their interest rate re-sets on average every few months.
The rate is tied to the London Interbank Offered Rate (called LIBOR), which is added to the fixed amount of each loan set at origination. For that reason investors look at bank loan funds and other adjustable-rate securities as short-term vehicles that do not have the interest-rate risk of long-term bonds.
In a rising-rate environment bank loan funds can and will raise their monthly dividends. That, together with their attractive yields today, make them worth a closer look.
What is the risk? Nearly all the loans in the funds are below investment grade (read “junk bonds”). That means the ability of the borrower to pay is more closely tied to the economy than to the level of interest rates. They would not do well in a recession. Still, because the loans are senior and secured, recovery in the event of a default would be higher than with other loans.
As before, my favorites are Eaton Vance Floating Rate Trust (EFR), which currently yields 6.4 percent and PowerShares Senior Loan Portfolio (BKLN), which yields 4.7 percent.
Although I expect rates to remain low for quite some time, it’s comforting to hold some securities that will benefit when rates begin to rise. After all, that day will come. It’s not a matter of “if,” it’s a matter of “when.”
David Vomund is an Incline Village-based fee-only money manager. Information is found at www.ETFportfolios.net or by calling 775-832-8555. Clients hold the positions mentioned in this article. Past performance does not guarantee future results. Consult your financial advisor before purchasing any security.