Loan Fund Primer
Sweden is now the latest country to make headlines about extreme central bank policy to stimulate growth which creates a dilemma for Swedish people trying to save money. This highlights the need to learn about different sectors of the fixed income market and taking a multi-sector approach in your fixed income portfolio. One sector that has attracted attention and assets has been the loan market. By Roger Nusbaum, AdvisorShares Strategist Last week the Riksbank (the Swedish central bank) dropped its benchmark interest rate to -0.10 and as of earlier this week Sweden’s ten year sovereign debt was yielding 0.50%. So Sweden is now the latest country to make headlines about extreme central bank policy to stimulate growth. We will see whether this turns out to be effective policy but it creates a dilemma for Swedish people trying to save money. This is the same or similar dilemma for people in many other countries including the US and while our rates are not as low as many other countries they are low enough to be problematic; two basis points for a money market and 2% for ten year treasuries. We’ve been looking at this issue for years, making the point about the need to learn about different sectors of the fixed income market and taking a multi-sector approach in your fixed income portfolio. We’ve talked about combining sectors with higher yields and so potentially more risk with sectors with lower yields and likely less risk to get an overall yield that hopefully approaches a useful level even if not a normal level; normal based on historical interest rates. One sector that has attracted attention and assets has been the loan market. There have been traditional mutual funds offering access for a fair bit of time and in the last couple of years ETFs have been rolled out that target the sector and the asset flows have been huge, more than $5 billion for the largest fund in the group. The attraction is simple enough; yields can be in the four percent range and because of their reset feature they don’t take interest rate risk. ‘Reset feature’ means that the interest rate paid on the loans adjusts based on prevailing rates on a regular interval, usually every three months. If you look on the info page for a loan fund you’ll see a maturity of several years but you’ll also see something like average days until reset which is when the rate on a given loan will update. From quarter to quarter there may not be much change but occasionally there will. This entire mechanism reduces interest rate risk to being essentially a non-issue. The credit quality of course tends to be lower which accounts for the yields being relatively attractive. Credit risk is generally mitigated, but not completely mitigated, by accessing the space via a fund similar to high yield. I would note that accessing an individual loan is not really a possibility for individuals. The other risk to mention is liquidity risk. Loans don’t trade on a secondary market so during some sort of event that strains liquidity the funds and their holders could have a problem with short term volatility. Most of the funds have the flexibility to hold some bonds that do trade on a secondary market to help in the face of a liquidity event. Anyone interested in the space, and with the yields available it is worth learning about, should take the time to understand what their given fund will do to address this potential issue. Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it. The author has no business relationship with any company whose stock is mentioned in this article. Additional disclosure: To the extent that this content includes references to securities, those references do not constitute an offer or solicitation to buy, sell or hold such security. AdvisorShares is a sponsor of actively managed exchange-traded funds (ETFs) and holds positions in all of its ETFs. This document should not be considered investment advice and the information contain within should not be relied upon in assessing whether or not to invest in any products mentioned. Investment in securities carries a high degree of risk which may result in investors losing all of their invested capital. Please keep in mind that a company’s past financial performance, including the performance of its share price, does not guarantee future results. To learn more about the risks with actively managed ETFs visit our website AdvisorShares.com .AdvisorShares is an SEC registered RIA, which advises to actively managed exchange traded funds (Active ETFs). The article has been written by Roger Nusbaum, AdvisorShares ETF Strategist. We are not receiving compensation for this article, and have no business relationship with any company whose stock is mentioned in this article.