Spreads measure yields relative to other market rates, generally Libor or Treasuries. If Libor is 1 percent and bank loans yield 5 percent, the spread is 4 percent. Relative spreads are useful ways to measure yields across fixed income categories, and are particularly helpful now with historically low Treasury yields driving down rates across the bond market.
Given that backdrop, floating rate bank loan funds appear to be reasonably priced on a relative yield basis. According to JP Morgan analyst Peter Acciavatti, the spreads on bank loans relative to Libor are currently 511 basis points, a number that has remained steady since 2008 and is above the 2007 pre-crisis level of 377 basis points.
Graff believes bank loans are decently priced relative to Treasuries but aren’t cheap on an absolute basis. “Absolute yields are currently near historic lows,” he says. “Spreads today are tighter than their long-term average, but still wider than their all-time lows.”
In other words, bank loans are a decent house in a bad neighborhood.
Fund Options
There are an ever-growing number of funds in the bank loan space. Morningstar tracks 41 mutual funds in this sector, and three new funds launched in the fourth quarter alone, including one from DoubleLine. There are also two exchange-traded funds focused on bank loan exposure––the PowerShares Senior Loan Port (BKLN) and the Highland/iBoxx Senior Loan ETF (SNLN).
Both Bush and Graff say investors need to look beyond the numbers when selecting these funds.
“Don’t buy these funds solely on yield because entrants in this category have differing risk approaches,” Bush says. “Some use leverage to enhance returns, some use high-yield bonds, and credit quality varies.” She notes that the ING Senior Income fund (XSIAX) tries to boost returns with leverage, while the Credit Suisse Floating Rate Hi Inc Institutional fund (CSHIX), has converted from being a strictly high yield bond fund to a floating rate fund.
Bush's favorite names in the group are Fidelity Floating Rate Hi Income fund (FFRHX) and the Eaton Vance Floating Rate fund (EABLX). “We favor relative conservative funds with lower yields,” says Bush, who also assigns a negative rating to one fund, the Lord Abbott Floating Rate Fund (LFRAX) due to management turnover.
Graff also likes the FFRHX and EABLX funds. “We usually prefer the more conservatively positioned bank loans funds,” he says. “We are willing to give up some upside potential in order to have superior downside protection. The Fidelity Floating-Rate High Income Fund and the Eaton Vance Floating Rate fund are two funds we think serve that purpose well.”