Bank Loan Funds...Buy now?

[RockOn]

I'm a retiree looking for income. I've been watching the bank loan funds for some time and think they look interesting. I realize they are simlar to junk bonds in some ways but they have a senior status reducing the risk. They are also adjustable rate, removing interest rate risk, which could be either a good or bad thing. Many of the funds are trading at recent or even all time lows (the open end mutual funds). Yields vary from about 6.5 to almost 10%.

Can anyone help me understand the risk and enlighten me with why they are near all time lows? Even junk bonds have turned up some lately. Am I naive about the risk?

Thanks in advance!

 

[brewer12345]

I have started buying a closed end bank loan fund. I think these funds are a potentially attractive way to get exposure to the beaten up junk market, but you want to keep this to a modest amount of your portfolio if you decide to buy.

In general, bank loans are senior to bonds so if an issuer goes bust the bank loan investor loses less money (on average).

I think the bank loan market is a mess because there are a ton of loans that financed the stupid LBOs of last year that the investment banks cannot sell. They would love to sell them, but buyers don't want these low quality loans. SO supply currently exceeds demand. Bank loans would also get scuffed up if the economy slows further and more borrowers start going bankrupt.

So if you have some risk tolerance, bank loans might be attractive. I don't think they are as risky as equities, but they are a far cry from treasuries. Be aware that many of the closed end funds in this space use leverage to try to juice returns.

 

[RockOn]

Thanks for the info. I've been looking at bgt, frb and nsl in the closed end area. Some are trading at 8% discounts to NAV with around 9% yields. These are off their bottom a little while the open end funds continue to make new lows everyday. How much do you think can be put in these. I'm thinking of going as high as 20%, would that be nuts?

 

[brewer12345]

Assuming you are really a retiree and dependent on your portfolio for income, I would keep it to no more than 10%. And if you get up that far, make sure you toss out any other junk funds you might have.

 

[RockOn]

I'm almost a real retiree, age 53. I gave up my real job a few years ago. I still do some consulting work since I have 2 kids. One in college and one going next year. I still work to pay for that so I don't have to draw down my account.

Anyway thanks for you advice, I thought these might be safe enough for 20%. The yield is great, I just have a hard time understanding the risk. I've read quite a few reports saving these are unjustly undervalued right now.

 

[haha]

I'm almost a real retiree, age 53. I gave up my real job a few years ago. I still do some consulting work since I have 2 kids. One in college and one going next year. I still work to pay for that so I don't have to draw down my account.

Anyway thanks for you advice, I thought these might be safe enough for 20%. The yield is great, I just have a hard time understanding the risk. I've read quite a few reports saving these are unjustly undervalued right now.

Brewer is giving good advice. Take a look at the ISM/OSM thread. These were excellent A rated issues paying very good returns, largely because they were not well understood. I invested in size-maybe 20%- because I thought, wow, this handles a lot of my income need and inflation exposure.

Ka-Boom! Nothing was wrong with the analysis, the only thing wrong was that other than short term US Treasuries, you can always get blindsided by totally off the wall events.

I have a little altar in my apt where I thank the saints for getting me out of that almost whole; and to remind me not to make that boneheaded allocation decision ever gain.

I would look at something like you are referring to as no safer and possibly not as safe as a blue chip equity like P&G or GE, bought at a good price. I would not invest more in a bank loan fund than I would put into a top line stock.

Ha

 

[RockOn]

haha, thanks for your input, it does me pause. I did read the ism/osm thread.

To me the bank loan funds are a little different than that situation. These funds are a diversified holding, that is a significant difference. I realize they lend to lower rated companies, many with a B rating. The two things making them better than junk bonds are that the loans are typically shorter term, and they are senior securities.

The funds haven't been around very long so the default risk cannot be evaluated.

In any case I noticed the open end funds such as FFRHX, XSIQX, got clipped again today. It has been happening daily for some time. The junk bond funds are up in the last week. It is hard for me to figure out why these funds keep going down when junk is at least trying to stage a recovery.

Is this simply the "baby with the bathwater" ?

 

[twaddle]

Junk spreads widen during economic slumps. You ain't seen nothin yet.

The standard academic argument against junk is that you're taking equity-like risk, but you're getting bond-like returns. Lose-lose.

Bernstein likes junk when the spread gets very wide, though.

Credit Risk

 

[RockOn]

twaddle, Markit CDX quotes show junk to be at about a 5% spread right now. That is Bernsteins buy level. Could this be near the bottom of the junk fall? With the Fed down to 3% and the stimulus on the way, the economy may not slow much more.

That being the case, the bank funds look to be a fire sale at current yields? At least that is the question I am asking.

Edited: after reading Bernsteins article again, I might be wrong about the 5% spread being a buy level, he might be saying a 10% spread, how do you read it?

 

[twaddle]

Brewer is the credit analyst, so if you want prognostication, he's your man.

I think you're slightly misreading Bernstein. He sets the forward expected return difference threshold at 5%, not the spread.

Personally, I'm leaning towards the academics. If you want equity-like risk, go with equities. Bonds should be short-term and high-quality.

 

[RockOn]

twaddle, thanks for the reply, I caught that I was off on that Bernstein spread value, sorry it took me awhile. Being new, I didn't know Brewers was "the man" on credit. I'll take his advice. I noticed he said he is nibbling in this area so I might not be completely out to lunch on these funds.

 

[ats5g]

Rock,

Use Bernstein's formula:

J-T spread - 7% * .6

@ 5% that's a 0.80% risk premium over treasuries. I'd keep waiting.

A J-T spread of 5% may be the bottom of the buy range, but certainly not enough to entice me.

- Alec

 

[haha]

twaddle, Markit CDX quotes show junk to be at about a 5% spread right now.

Rock On, I am not familiar with this site. Could you link it?

Ha

 

[RockOn]

haha, sorry, i posted the reply in the wrong thread, rookie mstake. Please check the links in the current Stimulus Thread.....

 

[RockOn]

The Bank Loan funds are almost in free fall now (some are 4% down in two weeks). Glad I didn't get in yet. Apparently these funds are not as safe as I thought. Senior securities apparently doesn't mean much. Junk bonds are declining but not as much as these.

They are probably approaching a screaming long term buy but I am too afraid, just like I was afraid to buy condo's in 1990 when they were almost giving them away. Fear and Greed!