Key Qualities of Floating-Rate Funds

Floating-rate funds are a type of investment that can provide regular income for the investor. Many times these funds will invest in floating rate loans from banks in order to provide returns to the investor. If you are considering investing in this type of loan, here are a few key qualities that you will need to be aware of.

Limited Time Frame

With this type of fund, the time frame of the loans are limited. This is not considered to be a long-term investment, like most bonds are. This means that they are less susceptible to interest rate risk. A floating-rate loan is one where the interest rate fluctuates. In most cases, the rate will change every month, or every 60 to 90 days.

The fluctuations mean that the value of the fund will always be changing based on the newest interest rate changes in the loans. This type of investment is very popular when interest rates look like they will rise in the near future. Many people who regularly only get involved in fixed income investments will get on board with a floating-rate fund to take advantage of the rising rates.

Junk Status and Seniority

Another factor for you to consider is that these funds are considered to be of junk status. Floating-rate loans are typically granted to companies that have negative credit histories. Otherwise, they may be able to qualify for a low, fixed-rate loan instead. Since the banks are lending this money to companies that have poor credit histories, this creates a riskier situation for investors in the loans. Although this type of debt is a little better than junk bonds because of the seniority of the debt. If the company goes into default, the lender will be able to recover most of the debt through the collateral.

Diversification

This type of investment also provides the investor with some diversification. The mutual fund will use the money to purchase many different floating-rate loans. This means that even if one of the loans goes into default, it will not negatively affect the entire mutual fund that much. This provides a level of protection to the investors in the fund.

Niche Market

This is still considered to be a niche financial market. When compared to some of the other financial markets in the world, there really are not that many investors in the floating-rate loan market. Since there is relatively low liquidity, there are bigger opportunities for fund managers to profit from the market. If there is a pricing discrepancy, a sharp manager can recognize the opportunity and take advantage of it. This has the potential to increase profits for the floating-rate mutual fund. These funds are structured uniquely and so that there is not that much competition for the floating-rate loans in the fund market. This provides the fund with plenty of opportunities to grow.

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