50% ST Bond Funds + 50% Bank Loan Funds?

[hapahc]

(This is my first post, so apologies in advance for any blunders!)

A June '07 Consumers Reports analysis recommends a short term investment strategy of 50% bank loan funds (specifically FFRHX) and 50% short term bond funds (like GVSBX or USSBX).

CR's testing concluded that by using this strategy, "you would have beaten the average money fund in each of the last 7 years and 13 of the last 15 years. The 50-50 mix also beat the average 1-year CD yield, as reported by Bankrate.com, in 12 of the last 15 years."

They tested over various time periods going back 15 years and found that "The mix worked better more than 90 percent of the time."

(For CR subscribers, the complete article is here: ConsumerReports.org - Best places for short-term funds, the best mousetrap )

I'm looking for a relatively safe place to park a fairly substantial amount of money for the next 2 to 3 years, and this 50-50 mix looks intriguing.

BUT, I just read the thread "Bank Loan Funds...Buy now?" and I understand that these funds can be very volatile. Can I interpret that to mean that this 50-50 mix broke down severely this year? Or, is it still a potentially sound strategy in the current market environment (assuming a 2 to 3 year horizon).

Any comments or insights (hopefully quantitative)?

 

[brewer12345]

Perhaps it would be helpful to understand what is in bank loan funds to give a bit of context. These funds own floating rate (LIBOR based) loans that were made to (usually) junk rated companies. While this may sound iffy, the loans are generally the first in line to get paid, ahead of senior bonds, subordinated bonds, preferred, equity, etc. They also usually have the tightest covenants and other protections for the lender (restrictions on additional borrowings, requirements for minimum earnings levels, etc.). As a consequence, most of the time the bank loans do not default even though the issuers are not of the highest quality, and when they do default the losses are far, far smaller than is the case with junk bonds (which come after the bank loans in the "who gets paid first" hierarchy.

So if you buy a bank loan fund, you are buying junk credit risk but the loans generally are pretty well secured and don't actually have bog problems when the defaults do crop up. In return, the loans typically pay a coupon that is LIBOR plus maybe 3% (roughly 5.5% around now) based on par. If you buy a bank loan fund now, you are probably getting in at something on the order of 85 cents on the dollar, so the yield is higher and the likelihood of losing a significant amount of money from a default is that much smaller (since 15% losses are already baked into the price you are paying). Bank loans also generally mature within 7 years (max), so you eventually get back to par via the loan maturing relatively quickly.

Where the volatility comes in is in the market price for these loans. They trade, but they are far less liquid than junk bonds (which are a lot less liquid than equities) and a lot of the people who own these have borrowed money to buy them (which means that they may be forced to sell at some point, regardless of the underlying value). So you will see plenty of price volatility in bank loan funds, but it is debatable whether this means much in the long run as far as recovering par.

So is the 50/50 strategy a good one? Possibly. The key thing to remember about it is that it is undeniably riskier than simply putting money in a CD. If you are comfortable with that risk, can afford to take it, and feel you are being adequately compensated for it, maybe it is worth considering. If, OTOH, you absolutely must have the money available at a certain date, perhaps a CD or savings account would be a better idea.

 

[hapahc]

So the article's assertion that, "Bank-loan funds outperform the other short-term alternatives when rates go up; and, short-term bond funds win when rates go down" is a wee bit simplistic?

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[cute fuzzy bunny]

I think I can shorten this up by saying that consumer reports is good at testing vacuum cleaners and food processors.

Finance? Not so much.

I'm thinking you're better off waiting until you can get a 5.75+% rate on cd's and buy a ladders worth.

Doesnt solve the "what do I do with my cash right now" problem. For right now I'd buy some ST corp for cash I wouldnt be touching for a while and cherry pick some cd's.

http://www.fatwallet.com/forums/finance/682884/

 

[brewer12345]

So the article's assertion that, "Bank-loan funds outperform the other short-term alternatives when rates go up; and, short-term bond funds win when rates go down" is a wee bit simplistic?

Just a tad. Put it another way: bank loan funds are an investment, CDs are a cash equivalent. If you want to consider an investment, go nuts. If you are just looking for a place to put cash that will remain readily accessible, a bank loan fund probably isn't the greatest idea.

 

[Nords]

Just a tad. Put it another way: bank loan funds are an investment, CDs are a cash equivalent. If you want to consider an investment, go nuts. If you are just looking for a place to put cash that will remain readily accessible, a bank loan fund probably isn't the greatest idea.

Seems like we spend an order of magnitude more time on this board chasing yield, one basis point at a time, than we do on equity asset allocation.

Instead of keeping my cash in loser 0.5% checking accounts, I'm gonna put it all in inverse-floater collateralized beever cheeze futures swaps... but sssshhh, don't tell Consumer Reports or they'll ruin it for us ground-floor investors!

 

[ipatent]

Given the turmoil in the capital markets, I wouldn't park a lot of money in any bank loan fund right now.

Put it in short term Treasuries or if you are worried that the dollar will fall further put it in an international short term government bond fund. I like the Merk Hard Currency Fund or the Prudent Bear PSAFX fund.

 

[brewer12345]

Prudent Bear PSAFX fund.

You are recommending a gimmicky bond fund that charges 1.27% annually? You need more tinfoil.

 

[ipatent]

You are recommending a gimmicky bond fund that charges 1.27% annually? You need more tinfoil.

The category expense average per Yahoo is 1.19%. Not a big difference, and it is actively managed with some PM mining stock exposure. Five star Morningstar rating. Along with MERKX it is a nice way to hedge against further dollar depreciation, IMHO.

 

[brewer12345]

Um, but if you want a non-USD bond fund you can get it a lot cheaper.

 

[ipatent]

Um, but if you want a non-USD bond fund you can get it a lot cheaper.

Suggestions?

 

[brewer12345]

GIM for one. BEGBX. There is also an etf: BWX. All are cheaper than the wonky Tice-run fund.

 

[ipatent]

GIM for one. BEGBX. There is also an etf: BWX. All are cheaper than the wonky Tice-run fund.

YTD return:

GIM 0.3%
BEGBX 4.2%
BWX 3.70%
PSAFX 6.56%
MERKX 7.45%

I'm not fretting about the additional 0.08% yet.

 

[brewer12345]

Your numbers are suspect. When I stick GIM into bloomberg and ask for total return from 12/31/07 to today, I get 8.3% with dividends reinvested.

 

[ipatent]

Your numbers are suspect. When I stick GIM into bloomberg and ask for total return from 12/31/07 to today, I get 8.3% with dividends reinvested.

I was using Yahoo. It had the YTD figures for all of the above except, GIM, which I calculated by comparing the 1/2 price with the current price. However all of the other YTD prices were at 6/30 so you are right it isn't apples to apples.

What does Bloomberg give you for the others?

 

[ipatent]

Per Bloomberg

3 yr returns

MERKX 12.08
GIM 10.73
PSAFX 10.26
BEGBX 6.98

I'll still take PSAFX over GIM because the former invests in safer government debt.

 

[cute fuzzy bunny]

Can I pick "none of the above"?

I'm thinking that if the dollar depreciates much further we'll be having bigger problems than which fund we picked.

 

[brewer12345]

I'll still take PSAFX over GIM because the former invests in safer government debt.

Whatever you say, sport.