Floating rate funds can offer a hedge against rising interest rates; here's a look at the basics of these funds, along with our top picks, says Walter Frank in MoneyLetter.
Floating rate—of bank loan—funds invest in floating rate loans, which are issued by firms with below-investment grade refit ratings.
Compared to traditional bonds, which are issued by a firm directly to the public, floating rate loans are issued by banks to firms that need to raise capital. Then, these loans are repackaged for sale to investors.
Traditional bonds generally have a fixed coupon rate that does not change for the life of the bond. In the case of a floating rate security, interest payments are based on a floating rate that is reset periodically, usually every 30 to 90 days.
That means that, even should interest rates climb, the securities should be fairly well protected from price declines, since the interest rate reset is never far away.
Eaton Vance Floating Rate (US:EVBLX), yielding 3.72%, invests in a broadly diversified portfolio of firms. The long-time management team focuses on fundamental credit analysis, liquidity, asset coverage, and management strength.
It has about 750 securities; healthcare is the largest sector, followed by business equipment and services.
Fidelity Floating Rate High Income Fund (US:FFRHX), yielding 3.09%, also emphasizes fundamental credit research, and while manager Eric Mollenhauer is relatively new to the fund (April 2013), he has been with Fidelity's high income group for 18 years.
The fund, with about 500 holdings, has traditionally been one of the more conservative in the category.
PowerShares Senior Loan Portfolio (BKLN) was the first ETF in this category. It tracks the S&P/LSTA US Leveraged Loan index, which is one of the 100 largest loans in the broad universe. Geographically, 90% of assets are in the US. The ETF yields 4.5%.
T. Rowe Price Floating Rate Fund (US:PRFRX) has nearly 400 holdings, with 82% in the US. About 52% of assets are in cyclical sectors, 41% in defensive, and the remainder in cash.
Manager Paul Massora says, in series, healthcare, information technology, and financials are the fund's largest exposures. The fund yields 3.62%.
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