An article published January 12 in the online version of Financial Advisor cites an inflow of capital into funds investing in floating rate loans. The expectation is that these funds will hold their value better than fixed income securities, such as Treasury bonds.
The funds invest in floating rate leveraged loans. They are typically less than investment grade, though senior in the capital stack to term loans and bonds. The interest rates on these loans tend to lag the general movement of rates due to loan terms (adjustment period and choice of reference rates) and payoff as credit quality improves. Thus, the dividend will stay fairly stable in both rising and falling interest rate environments. The principal value tends not to fluctuate with changes in interest rates, but can change dramatically with general economic conditions. Witness the decline in NAVs among some of the oldest and largest of the funds in 2008: Eaton Vance Floating Rate Advantage B (EBFAX) - down 43%; Invesco Van Kampen Senior Loan IB (XPRTX) - down 54%; Black Rock Senior Floating Rate I (XMPFX) - down 34%; Invesco Prime Income Trust (XPITX) - down 41%. The NAV for the Eaton Vance and Invesco Van Kampen funds have returned almost entirely to their December 2007 levels.
The bottom line is this: these funds will tend to reduce volatility due to interest rate fluctuations. However, they are highly exposed to credit risk. They can work to enhance returns in a rising interest ate market, (which is often associated with improving economic conditions). They are not simple trade off for Treasury securities.
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