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What do I need to know before investing in a Bank Loan fund?
Bank loans are usually floating-rate loans by banks (FR/BL) to startups and emerging and small companies that cannot tap the regular bond market or afford fixed-rate loans. So, FR/BL have junk ratings and have higher correlation with stocks and economy. Another aspect is that the floating-rate feature has little value when the rates fall, and then they act just like short-term HY. FR/BL have done well recently.
That also leads one onto floating-rate securities. The following act quite differently from the above FR/BL.
There are 2-yr Treasury FRNs that reset weekly according to 3m T-Bills + spread. There is no credit risk and the reset feature removes the duration risk.
There are also investment-grade corporate floating rate securities. The credit rating is obviously higher. Again, they benefit most with rising rates.
M* piece on floating rate funds, from mid 2022. It mistakenly says there are only two "medalist" floating rate funds. Fidelity's FFRHX is also a silver medalist.
In addition to the types of floating rate securities Yogi mentioned, there is also the late, unlamented category of adjustable rate mortgage funds. ARMs were very hot (with homebuyers) for a short time in the early to mid '90s as people looked for ways to reduce mortgage costs.
Investing mostly in government-backed mortgages, these ARM funds had little credit risk and in theory (being adjustable rate) little duration risk. It didn't work out that way for a variety of reasons including lag in adjustments - they often had multi-year "starter" rates. Even after a starter period ended, the loans adjusted only once or twice a year, and only within specified limits. More recently, over the past several years performance has been slow (very slow) and very steady. Not recommended, but mentioned for completeness.
Few of these funds remain. As mortgage rates declined over the years, the demand for ARMs (and thus the supply of debt) shrank. Consequently, one of the three surviving ARM funds, Franklin Adjustable U.S. Government Securities Fund FISAX changed its objective to ARMs and fixed rate mortgages last year. It is now Franklin Low Duration U.S. Government Securities Fund. https://www.franklintempleton.com/forms-literature/download/Notice-FranklinAdjustableUSGovernmentSecuritiesFund
The remaining adjustable rate funds are FEUGX (Schwab Select List) and ESAAX.
BL funds are usually a good place to be when rates are going up. The Fed told promised us to raise rates since early 2022 and why BL have been doing well.
Rather than the Fed "promising" rate changes, it "expects" or "predicts". That said, even before "early 2022", i.e. in December 2021, it "predicted" three interest rate hikes for 2022.
But in 2022 following that "promise", bank loan funds lost an average of 2.49% (data from M*). If one wants to say that "doing well" is a relative statement, then sure, bank loan funds did well.
Except relative to ultrashort fixed rate funds. As a group, those went down "just" 0.14% in what has been described as the worst year ever for bonds.
Even worse was how bank loan funds performed in the first six months of 2022 right after the Fed press release. By July 8, 2022, bank loan funds were down 5.8%, underperforming not only ultrashort bond funds, but short term bond funds as well. (Graph from previously linked M* article.)
The point is that while bank loan funds tend to do better than other funds when interest rates go up, that's only one (albeit major) factor in how these funds actually perform in any given period of time.
Sometimes Fed predictions are wrong. It "predicted" 3 quarter-percent rate increases in 2022. It actually raised rates by a quarter point only once in 2022. But it raised rates by 1/2 or 3/4 percent six other times that year. Shouldn't bank loan funds have done even better as a result? Macroeconomics is hard.
Since the advent of the Credit Suisse Leveraged Loan Index (floating rate bank loans) in 1992 there have only been three down calendar years. 2008, 2015, and 2022. In each case the index bounced back sharply the following year more than making up for the losses.
With 2023 on track for the category’s second best year since 1992 some could argue we are in the later innings of this move. Investors are notorious for chasing what has been hot based on recent performance and then regretting it. And recent performance since we began discussing bank loans here over the past many months has been exceptionally robust.
From my point of view, the Fed officials "screamed" for weeks that they were going to raise rates. This is when the Fed officials come on TV several times and make the case for raising rates aggressively for weeks. 2022 was one of the worst years. Doing well is relative.
There is a related article on leveraged loans in the Wall Street Journal "The Market-Beating Investment That’s Defying Wall Street Skeptics. Rising interest rates are boosting risky corporate-loan returns instead of hurting them"
There is a related article on leveraged loans in the Wall Street Journal "The Market-Beating Investment That’s Defying Wall Street Skeptics. Rising interest rates are boosting risky corporate-loan returns instead of hurting them"
Can’t read the article so don’t know if it was positive or hopefully negative to keep out the weak hands from rushing in. But bank loans are getting noticed now after its huge run here and there. Never a good sign. They have been quiet this week. Depending on what the Fed says this afternoon and how prices react may take some off the table. Did that previously and was wrong only to have to ramp back up. Normally trends that are in place this time of the year like in bank loans run till the end of the year. So we shall see.
I still maintain a position in SPFPX which is now known as American Beacon FEAC Floating Rate Income Fund which was formerly known as American Beacon Sound Point Floating Rate Income Fund.
Saw something from Steph Pomboy on X where an Illinois pension fund is shifting from high yield junk bonds to bank loan floating rate bonds and private credit. To her this is a “peak risk” headline. Hopefully it will get more crazier bullish in bank loans before the bottom falls out.
Basically, Illinois is consolidating many local police pension funds into a big state level police pension fund. But this is under litigation as many locals like to "play" with their own underfunded pension funds. This is hurdle# 1.
If it is overcome (as it was for IL Firemen pension fund), then the designated managers are soliciting bids for junky FR/BL by December 2023. Then, they will decide if/how many such external managers may be hired, and how these may be made available.
If FR/BL are so bullish, why have PRFRX and FFRHX been in redemption for probably 1 1/2 years?
Just read in Wednesday's WSJ that individual investors have pulled $13 billion from FR/BL mutual funds and ETF's this year. Are they the "smart money" or the "dumb money"?
If FR/BL are so bullish, why have PRFRX and FFRHX been in redemption for probably 1 1/2 years?
Just read in Wednesday's WSJ that individual investors have pulled $13 billion from FR/BL mutual funds and ETF's this year. Are they the "smart money" or the "dumb money"?
Asking for a friend.
There is nothing more bullish than a bond category that is steadily rising amid heavy fund outflows. Early 2014 in junk munis come to mind. Once inflows become heavy and consistent the party is nearing an end. One of the most bullish things about bank loans earlier in the year and which I alluded in June was the steady and persistent outflows. In fact outflows had been the story for years on end. Most recently the outflows have reversed into small inflows. Hopefully @yogibearbull can shed more light on recent flows. Overall I have never been much of a fan of the bank loan category (except for mid to late 2016) because they could never compete with junk corporates performance wise. Obviously this year another rare exception.
Edit: The 10 year in the overnight market is trading at 4.44%. Yikes!
Comments
That also leads one onto floating-rate securities. The following act quite differently from the above FR/BL.
There are 2-yr Treasury FRNs that reset weekly according to 3m T-Bills + spread. There is no credit risk and the reset feature removes the duration risk.
There are also investment-grade corporate floating rate securities. The credit rating is obviously higher. Again, they benefit most with rising rates.
In addition to the types of floating rate securities Yogi mentioned, there is also the late, unlamented category of adjustable rate mortgage funds. ARMs were very hot (with homebuyers) for a short time in the early to mid '90s as people looked for ways to reduce mortgage costs.
Investing mostly in government-backed mortgages, these ARM funds had little credit risk and in theory (being adjustable rate) little duration risk. It didn't work out that way for a variety of reasons including lag in adjustments - they often had multi-year "starter" rates. Even after a starter period ended, the loans adjusted only once or twice a year, and only within specified limits. More recently, over the past several years performance has been slow (very slow) and very steady. Not recommended, but mentioned for completeness.
Few of these funds remain. As mortgage rates declined over the years, the demand for ARMs (and thus the supply of debt) shrank. Consequently, one of the three surviving ARM funds, Franklin Adjustable U.S. Government Securities Fund FISAX changed its objective to ARMs and fixed rate mortgages last year. It is now Franklin Low Duration U.S. Government Securities Fund.
https://www.franklintempleton.com/forms-literature/download/Notice-FranklinAdjustableUSGovernmentSecuritiesFund
The remaining adjustable rate funds are FEUGX (Schwab Select List) and ESAAX.
toldpromised us to raise rates since early 2022 and why BL have been doing well."The Federal Reserve said [on Dec 15, 2021] it would ... pave the way for three quarter-percentage-point interest rate hikes by the end of 2022".
https://www.reuters.com/markets/us/fed-prepares-stiffen-inflation-response-post-transitory-world-2021-12-15/
BL have been doing well.
Eventually (read 2023).
But in 2022 following that "promise", bank loan funds lost an average of 2.49% (data from M*). If one wants to say that "doing well" is a relative statement, then sure, bank loan funds did well.
Except relative to ultrashort fixed rate funds. As a group, those went down "just" 0.14% in what has been described as the worst year ever for bonds.
Even worse was how bank loan funds performed in the first six months of 2022 right after the Fed press release. By July 8, 2022, bank loan funds were down 5.8%, underperforming not only ultrashort bond funds, but short term bond funds as well. (Graph from previously linked M* article.)
The point is that while bank loan funds tend to do better than other funds when interest rates go up, that's only one (albeit major) factor in how these funds actually perform in any given period of time.
Sometimes Fed predictions are wrong. It "predicted" 3 quarter-percent rate increases in 2022. It actually raised rates by a quarter point only once in 2022. But it raised rates by 1/2 or 3/4 percent six other times that year. Shouldn't bank loan funds have done even better as a result? Macroeconomics is hard.
2022-2023 rate hikes (table in Fortune article)
With 2023 on track for the category’s second best year since 1992 some could argue we are in the later innings of this move. Investors are notorious for chasing what has been hot based on recent performance and then regretting it. And recent performance since we began discussing bank loans here over the past many months has been exceptionally robust.
2022 was one of the worst years. Doing well is relative.
Basically, Illinois is consolidating many local police pension funds into a big state level police pension fund. But this is under litigation as many locals like to "play" with their own underfunded pension funds. This is hurdle# 1.
If it is overcome (as it was for IL Firemen pension fund), then the designated managers are soliciting bids for junky FR/BL by December 2023. Then, they will decide if/how many such external managers may be hired, and how these may be made available.
STAY TUNED!
https://finance.yahoo.com/news/illinois-police-pension-fund-plans-194125760.html
Just read in Wednesday's WSJ that individual investors have pulled $13 billion from FR/BL mutual funds and ETF's this year. Are they the "smart money" or the "dumb money"?
Asking for a friend.
Edit: The 10 year in the overnight market is trading at 4.44%. Yikes!