With interest rates set to rise, is now the time for floating rate investments?
The instinct to gravitate toward floating rate securities when rates are poised to rise is entirely reasonable. Generally speaking, bond prices fall when rates rise (a fact that only 31% of investors surveyed by BlackRock in April correctly noted). Floating rate securities (typically bank loans) provide a measure of cushion versus fixed rate assets because their coupons reset with rising rates.
As the chart shows, floating rate securities have done well in the most recent three Federal Reserve rate-hiking cycles. But investors should keep these things in mind about the opportunity today:
- Recent popularity may be making bank loans expensive. Value seekers might prefer to await a pullback for new purchases.
- Floating rate bank loans are rated non-investment-grade and come with credit risk (e.g., risk of default). It may be prudent to own at the higher-quality end of the credit spectrum at the current point in the business cycle.
- With no open market for floating rate securities, investors generally own them in a managed product. Carefully select your provider given the quality and price considerations noted above.
While the current rising-rate environment elevates the case for bank loans today, Adrian Marshall, portfolio manager of the BlackRock Floating Rate Income Fund, encourages investors to consider the asset class as a core component of a broad credit allocation: “Yes, investors can benefit from floating rate coupons as rates shift higher, but the longer-term merits of the asset class, including high income, greater downside protection, and low volatility, are equally compelling."
Performance when the Fed raises rates
Average returns during tightening cycles
Source: Morningstar, as of March 31, 2017. Represents average performance during the three most recent tightening cycles: 11/15–1/17, 6/04–6/06 and 6/99–5/00. Past performance does not guarantee or indicate future results. Assets shown are represented by Morningstar categories, as named.
This article was originally posted on BlackRock Insights
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I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.