Variable rate loans can boost your portfolio


Variable rate bank credit funds, such as Fidelity Variable Rate High Income (symbol FFRHX, yield 3.7%) and Eaton Vance Floating Rate (EABLX, 3.8%), generated positive returns as the broader bond market was in the funk. I recommend them enthusiastically, at least for now. The category offers 4% returns with less risk of price pressure from rising rates (yields and prices move in opposite directions) than most traditional income investments. Indeed, these funds hold short-term loans whose interest rates adjust to changes in market rates. And with Federal Reserve Chairman Jerome Powell outspoken about the Fed’s intention to raise short-term rates in 2018 and 2019, fund payments are surely on the rise. (Yields and returns are as of June 15.)

But the majority of loans are rated poor, and bank loans will be one of the first categories of debt to suffer principal losses once economic growth slows and various commercial and industrial borrowers feel the pressure. In addition, bank loan funds and exchange traded funds are not the only interest-bearing securities whose distributions vary with interest rates. I therefore suggest that you now complete variable rate loans with other variable rate investments. When trouble comes, it’s better to be early rather than too late.

Ignore some of the heavily marketed alternatives. This includes TFLO, the Treasury Floating Rate Bond iShares ETF, and USFR, a similar ETF from WisdomTree. The funds mainly hold two-year Treasury floats. Their yield of just over 1.5% is lower than regular two-year T notes and only resets quarterly.

Instead, start with a simple money market mutual fund. These funds immediately pass on the higher rates influenced by the Fed. With such a flat yield curve (which means short and medium term rates are close to 10 and 30 year yields), a money market fund is a legitimate floating rate investment, especially if you choose one that pays off. closer to 2%. than the 30-day class average yield of 1.4%. Look first at the money fund attached to your brokerage account, or consider Vanguard Prime (VPMCX, 2%).

Find 4%

To get closer to that 4% of bank lending, consider Wall Street’s pipeline of unusual, neglected, or institutional-style floating rate debt offerings. These are high-quality investments that are priced to pay a premium over the benchmark 30-day or 90-day Interbank Offered Rate, or LIBOR (the three-month rate is currently 2 , 3%), backed by assets such as commercial mortgages on high-end office towers.

For example, RiverPark CMBS Floating Rate Fund (RCRIX, 4%) holds variable rate mortgage tranches on office buildings and trophy-type hotels in New York, Chicago and Philadelphia and resorts in Florida and Hawaii. The monthly distribution of the fund will reflect increases in LIBOR. RiverPark made the portfolio a public fund in October 2016, and it suffered no monthly losses; a Bloomberg Barclays Commercial Mortgage Index shows eight losses over the same period.

The venerable New FPA Income Fund (FPNIX, 3%) is a mix of auto loans, adjustable rate mortgages, and other good stuff with an average life of just two years. The fund’s return has increased by half a point since the end of 2017.

You can examine the holdings of any bond or income fund to see if most of their assets are floating rate. It is not yet a litmus test for the funds I recommend.

But I note that Capital of Arès (ARCC, 9.1%), which provides finance to small and medium-sized enterprises, prides itself on borrowing on fixed terms but granting loans and choosing portfolio investments at variable or adjustable rates. It returned 11.6% for the year through mid-June. All other things being equal, a hallmark of the variable rate is insurance against the Fed and inflation, and a good source of income as well.


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