Floating rate funds

[NewbieD]

I'm looking to read up on floating rate funds. Does the board have any thoughts on these or ideas for specific ones with good managers?

 

Are there other ways to invest in floating interest rates that are less fee-heavy?

[HJ]

They are mostly bank loan funds.  Closed end funds all have a bit of leverage, call it 30%, but higher expense ratios, generically 2% +/-, they mostly trade at a slightly discount to compensate for that, also tend to have a small allocation to HY bonds.  Liquidity is suspect, daily transaction dollar volume of a couple million, maybe more for the larger ones.  Greater than that liquidity needs you need to potentially deal with higher discounts.  The combination gets you to 6-7% dividend yield.  Alternative is the ETF's, Invesco runs BKLN (Bank Loan), the biggest.  Blackstone runs one for the Spider family, SRLN (senior loan).  They generically have lower expense ratio, less than 1%, but no leverage.  Less discount/premium issues to deal with, and can accommodate large sized liquidity needs.  Then there are some open ended unlevered ones out there you can research, mostly retail mutual fund shops run those.  Fidelity, Oppenheimer, etc. all have a version of these.  They have expense ratio similar to, maybe a bit higher than the ETF's.  Without leverage, the current dividend tend to be lower, 4-5%.

 

Beware that most bank loans these days have LIBOR floors, so they don't really get the benefit of the first 75-100 bps of rate hike, if that's what you are gaming for.  They will still be lower volatility than other fixed income alternatives.  Asset class is quite homogeneous, not sure management adds that much.  You are basically paying fees for access to the asset class.

 

If you want to be more venturesome, you can try for higher leveraged / higher fee versions, CLO equity funds like OXLC, ECC (generically 10x leverage), but you pay fee on fee (fee to the manager, call it 40-50 bps on portfolio to manage the CLO (which is 4%-5% on your 10x levered equity), and fee to the closed end funds).  The behavior of the asset changes as more and more leverage is added on to it.  Alternatively go for the deeper credit versions, which are essentially the BDC's.

[NewbieD]

Thanks for the heads up. I'm new to debt investing in general, but I think I understood most of it.

 

Some clarification questions:

Yup, part of what I was gaming for was to have a hedge against rising rates. The 75-100 bps of rate hike missed you referred to is because of 3-month update interval of LIBOR, yes?

 

BDC stands for what exactly? See that Goldman Sachs have one but they don't explain the acronym. Setup of OXLC is tempting but I think I'll have to refrain until I understand exactly what they do and what the risks are:)

[HJ]

Bank loans these days are typically structured with LIBOR floors of 0.75% - 1%, so the loan coupon is max(LIBOR, LIBOR floor) + spread.  For the first couple of rate rises, your loan coupon don't change.  After LIBOR goes through the floor, your loan coupon then adjusts in accordance with LIBOR.

 

BDC's stand for Business Development Companies.  Basically a tax structure, similar to REITs, except they make loans to middle market companies, sometimes subordinated loans.  In general these taker on greater credit risk than the "broadly syndicated loans" in these bank loan funds.  They do yield more, and a lot of BDC's also invest in CLO equities.  Their dividend is supposed to float, as most of their assets are floating rate based (also subject to LIBOR floor issue), but the manager will probably manage the actual dividend, so relationship between LIBOR and dividend yield is probably not 1:1.

 

 

[thepupil]

 

Yup, part of what I was gaming for was to have a hedge against rising rates. The 75-100 bps of rate hike missed you referred to is because of 3-month update interval of LIBOR, yes?

 

 

No, it's because loans will be priced something like this

 

3mL+300 w/ a 100 bp libor floor. 

 

Because of the floor that loan would be charging 400 bps (100 bp floor + 300). When 3mL goes up from current level of 29 bps, this loan won't pay anymore until libor goes above 100.

[Orchard]

Keep in mind that while floating rate loans theoretically protect against rising rates, the underlying companies will have to deal with the increased interest expense. A lot of the closed end funds invest in leveraged loans where some companies will go bankrupt once rates rise.