Making the Case for Floating-Rate Loans

May 23, 2014 12:00 PM
By Stephen Hillebrecht

Recently, we’ve been reading about modest outflows from floating-rate loan funds, industry-wide – a trend abetted by press reports that are questioning the benefits of the asset class. Lord Abbett has been a long-time investor in floating-rate loans, and we believe strongly that the asset class merits an allocation in a diversified fixed-income portfolio. Here’s why.  

Much of the hesitation about the asset class today is related to the timing of changes in interest rates, which depends, in turn, on investor expectations for the U.S. economy. For example, some have doubted the benefits of the asset class if short-term interest rates are expected to stay low for some time. However, the unexpected decline in Treasury bond yields in 2014 is a prime example of how difficult it is to correctly “time the market” for interest rates. 

We’re perfectly willing to share our economic outlook. Our base-case scenario for the U.S. economy is that growth will accelerate moderately this year. Moreover, we believe corporate credit fundamentals are likely to remain favorable, with companies benefiting from low interest rates, and we expect default rates to remain below longer-term norms. 

Obviously what we have just described leads to a continued positive credit environment for high yield bonds and floating rate loans. In such an environment, floating-rate loans can provide attractive income without the duration risk of fixed-rate bonds, with less volatility than high-yield bonds or equities, and as a source of portfolio diversification, given the low or negative correlation of floating-rate loans with other major asset classes. Of course, we would never suggest that loans be a replacement for a diversified fixed income portfolio.

More to the point is that an allocation to floating-rate loans, combined with allocations to short-duration bonds, intermediate high-quality, high-yield, and convertible securities, offers investors potential sources of income, while being positioned for any number of economic scenarios.

It’s not about timing the market. It’s about being in the market at all times. For all the above reasons, floating-rate loans should be considered as an allocation in a diversified fixed-income portfolio. 

Recommended reading: "Why Allocate to Floating-Rate Funds?"

What do you think? Join the investment conversation. 

Steve Hillebrecht is Lord Abbett Fixed Income Product Strategist.

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