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WSJ: Investors Flock to Bank Loan Funds, Creating Risk

By Dan Weil   |  

Individual investors are running to floating-rate bank loan mutual funds, which is making the sector more risky, experts say.

Companies with below investment-grade ratings – and often heavy debt loads – take out
floating-rate loans. So the interest rates on the loans are high. Some funds sport yields around 7 percent.

Investors are obviously attracted now by the yields. In addition, the loans’ rates are reset every three months. So when interest rates as a whole finally rise, the funds’ yields should rise, too.

Editor’s Note: Put the World’s Top Financial Minds to Work for You

Floating-rate bank loan funds have seen their assets expand 25 percent this year, far and away the highest growth rate of any mutual-fund category, according to Bank of America, The Wall Street Journal reports.

But bank loan values can fall as easily as they rise, just like their brethren junk bonds. In 2008, for example, the S&P/LSTA U.S. Leveraged Loan 100 index of floating-rate loans plunged 28 percent. Buying assets with low credit quality always entails risk.

And the more investors buy the funds, the lower their yields. In addition, all but two closed-end bank loan funds are now trading at a premium to their net asset values, according to Morningstar, which is often a sign that funds are overvalued.

The International Monetary Fund is worried about loosening standards for U.S. corporate
borrowing.

"In the United States, corporate debt underwriting standards are weakening rapidly," said José Viñals, head of the IMF's monetary and capital markets department, according to Reuters. "This is a cause for concern that needs to be monitored."

Editor’s Note: Put the World’s Top Financial Minds to Work for You

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Individual investors are running to floating-rate bank loan mutual funds, which is making the sector more risky, experts say.
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