Market Pulse: A vehicle for rising rates
May 22, 2018
Interest rates remain low, but recently have moved higher. That makes for a difficult and frustrating time for savers.
Still, for those willing to look "outside the box" there are vehicles that provide an attractive stream of income with acceptable risks. Bank-loan funds are one.
Bank-loan funds invest in loans made by banks to corporations most of which are unrated or rated below investment grade. Because the loan rates "float," their interest rate resets every few months and is linked to the London Interbank Offered Rate (called LIBOR).
For that reason, investors look at bank-loan funds and other adjustable-rate securities as short-term vehicles that do not have the 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, makes them worth a closer look.
What are the risks? There are two. First, nearly all the loans in the funds are below investment grade. In most cases 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 most loans are senior and secured, recovery in the event of a default would be higher than with other loans.
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The second risk comes from the use of leverage. The funds use some borrowed money to purchase additional loans. That's fine under normal conditions and enables the funds to pay more to investors, but they suffered during the financial crisis, as did virtually every investment. For that reason, these funds bear watching.
My favorite bank-loan ETFs are SPDR Senior Loan ETF (SRLN) and PowerShares Senior Loan Portfolio (BKLN). SRLN yields 4.1 percent and has an expense ratio of 0.70 percent. To show how it benefits from rising rates, its last monthly dividend was $0.175, up from about $0.12 in 2013. BKLN yields 3.72 percent with a management fee of 0.67 percent.
Although I expect rates to remain low for quite some time, it's comforting to hold some securities that will benefit as rates rise further. 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 http://www.VomundInvestments.com 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.