Two years ago I started investing in bank loan mutual funds for many of our clients. They are a great way to diversify a portfolio without giving up bond income. Last year our bank loan investments earned approximately 9% versus the Lehman Bros Aggregate ishares which earned only 4%. Not bad for a bond fund that is senior secured debt and regularly resets for interest rate changes.
Senior floating rate loans are loans made by U.S. Banks and other financial institutions to large corporations. Floating rate funds are less susceptible to interest rate risk than fixed rate bonds because rates are periodically reset to the prevailing interest rate. So if interest rates increase slowly this fund is less apt to generate a negative return. These loans are the senior source of capital in a borrower’s capital structure (they are first in line if the company goes bankrupt) and have some of the borrower’s assets (real estate, machinery, investments) pledged as collateral.
So if the borrower defaults on the loan the assets become the property of the mutual fund. The value of the collateral may not offset the full value of the loan but the Eaton Vance fund has tried to minimize the risk of default by monitoring creditworthiness of the borrowers carefully and spreading risk by investing the fund in over 450 separate loans. Rarely does a loan represent more than 1% of the fund’s assets. This broad diversification helps to minimize the impact of default.
Year-to-date the Instituional shares are up 2% versus the Lehman Bros Aggregate ishare ETF (AGG) which are up 1.7%.
Attached is a write up by Eaton Vance regarding bank loans.
http://www.eatonvance.com/alexandria/2096.pdf
The Financial Pragmatist
Libby Mihalka
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