In a period of rising rates, though, floating-rate funds usually outperform other bond-fund categories. In 2003, for example, when the Federal Reserve started raising rates, bank-loan funds gained 10.4% while short-term bond funds gained 2.5%.
Chris Scaringe, a 46-year-old chief financial officer of an industrial-services company in Albany, N.Y., started adding to his positions in floating-rate funds last year on the advice of Aaron Schindler, a New York financial advisor. Now he has about 20% of his portfolio in Eaton Vance and Fidelity floating-rate funds. "There's no way of avoiding higher interest rates and rising inflation," Scaringe says. "At some point it has to happen."
If the Federal Reserve raises rates next year, floating-rate funds could be poised to beat short-term bond funds in both yield and price appreciation, just as they did from 2003 to 2006, says Mr. Schindler, who uses the funds in nearly all of his clients' portfolios. During that period, the Fed raised the federal-funds rate 17 times, from 1% to 5.25%. Floating-rate funds beat short-term bond funds by about 4.2% a year during that period, according to Morningstar.
There are nearly 50 floating-rate funds, including closed-end funds, to choose from. BlackRock Inc., Blackstone Group LP's GSO Capital Partners and Goldman Sachs Group Inc. have recently launched new offerings or have ones in the pipeline. Morningstar's picks in this category include the Eaton Vance Floating-Rate Fund and the Fidelity Floating Rate High Income Fund, which boast experienced management teams and solid track records.
The Fidelity fund, which is the more conservative of the two, tends to stick with high-quality loans, a strategy that paid off in 2008, when the fund lost less than its rivals. Eaton Vance, which has a more aggressive style, "has one of the most experienced leveraged-loan teams," Morningstar's Mr. Jacobson says.
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