Investors Prepare For Rate Hike With These Funds

October 28, 2016

New York (Reuters) – Bank-loan funds that aim to pay investors more when interest rates increase are having their best fundraising streak in more than two years as buyers chase performance and the fulsome prices the investments now command.

The products, which are sold as mutual funds and exchange-traded funds such as the iShares Floating Rate Bond ETF (FLOT) and the SPDR Barclays Investment Grade Floating Rate ETF (FLRN), purchase floating-rate loans that will pay out more in interest if the key benchmark London interbank offered rate (Libor) crosses above the 1% mark. Three-month Libor is currently 0.89%.

Investors are eyeing the December U.S. Federal Reserve monetary policy decision with increased anticipation, as the central bank is widely expected to raise rates. Such a move could push Libor over that threshold, triggering floating-rate borrowers to boost their payouts.

Investors look to Libor to understand short-term corporate borrowing costs.

Typical Bonds Do Not Adjust Payouts

By contrast, a typical bond will not adjust what it pays out even as other interest rates in the market rise.

"This is a tried-and-true asset class for performance in a rising-rate environment," said Eaton Vance Corp institutional portfolio manager Christopher Remington. "Investors are getting ready." Nearly two-thirds of the S&P/LSTA Leveraged Loan Index's holdings are structured to pay more interest as soon as Libor rises above a 1% "floor," according to S&P Dow Jones Indices.

Three-month Libor has surged 43% since late June to seven-year highs, with a good portion of the increase tied to new regulations governing the pricing of money-market funds, easily traded investments generally considered as safe as a bank deposit.

The regulations forced money market funds that invest in corporate debt to let their share prices float with the market and possibly impose redemption fees in times of market stress.

In turn, those changes drove cash away from those funds, pushing borrowing costs higher for companies that depend on money markets.

 

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