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Those Bank Loan Funds Aren’t What You Think

This is the third and final article in a series addressing the turn in the stock market brought on by Federal Reserve statements about reducing economic stimulus. Part One provided an overview and examined how low-volatility stocks, in favor in recent years, might perform in a stronger economy and without the Fed pushing interest rates down. Part Two explored how investors – those interested in income-producing securities and others – might find growth in the changed environment.

Bank loan funds are all the rage. Morningstar reports that net monthly flows into this slice of the bond market over the past three months has averaged more than $5.3 billion, compared to an average monthly net inflow of $920 million throughout 2012. The near $20 billion in net inflows just in the first four months of 2013 has pushed the category’s total assets to $95 billion.

The market pitch seems so alluring. These securities have floating, rather than fixed interest rates like a 10-year Treasury. Perfect, you say? That’s just what you want if the Fed’s Big Taper begins soon?

Slow down and check out this chart showing the percentage change in interest rates over the past month.

10 Year Treasury Rate Chart

10 Year Treasury Rate data by YCharts

The 10-year Treasury rose from 1.67% to 2.1%, the 20-year from 2.5% to 2.9% and a high-grade corporate bond index saw its rate climb from 1.9% to 2.3%. Big jumps. The short-term LIBOR, not so much. It didn’t budge. And that’s the index that floating-rate/bank loans are tied to.

The Fed’s threat of tapering impacts the long-term bond market, as it’s been buying up mortgages. That’s a completely separate issue from what the Fed expects to do with its short-term Federal Fund rate. On that front, it has stated it doesn’t expect to raise rates until the unemployment rate gets below 6.5% and inflation rises above 2%. We’re still a long way from either occurring. The Fed continues to maintain it anticipates it will keep the Fed Fund rate stuck near zero through at least the end of 2014.

That makes it a tad early to be focused on floating rate funds. Besides, the fact that the segment has attracted so much money of late has made them less attractive; prices have been bid up, pushing yields down. The 30-day SEC yield for the $4.5 billion PowerShares Senior Loan Portfolio (BKLN) has fallen from 5.3% a year ago to 3.8% today. Near 4% sounding pretty good to you? Keep in mind these bonds are just another form of junk; low-rated paper that has a risk profile akin to stocks. That seems like a pretty slim payout to compensate you for the risk you’re taking. Especially if the floating allure probably won’t kick in for another year and a half.

Carla Fried, a senior contributing editor at ycharts.com, has covered investing for more than 25 years. Her work appears in The New York Times, Bloomberg.com and Money Magazine. She can be reached at editor@ycharts.com. You can also request a demonstration of YCharts Platinum.

Read more articles about: Investing Ideas  overall market   federal reserve   

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