When Rates Rise, Consider Floating-Rate Loans
Here’s our case for floating-rate loans during a rate-hike cycle.Download PDF
Compared to many fixed-income asset classes, floating-rate loans (also known as bank loans) have historically done well during past rate-hiking cycles. With expectations for several rate hikes by the Federal Reserve this year and in 2023, here are three reasons to consider investing in floating-rate loans.
1) Floating-rate loans have historically done well generating returns in rate-hike cycles, which typically have been a difficult period for traditional fixed-income asset classes.
2) The floating-rate nature of the asset class has helped investors during periods of rising interest rates, as the interest rate on loans typically resets every 30-90 days based on the new rate environment and generally move in tandem with the federal funds rate.
3) Floating-rate loans in 2021 recorded only five defaults, a low that's only been matched once in the last 14 years.
Default rates have always been a major factor for investors considering floating-rate loans, which is a primarily non-investment-grade asset class. But with default rates currently tracking well below their historic average of 2.53% (the percentage for January 2022 clocked in at 0.29%), the historical default risk could be significantly reduced in the near term.
Bloomberg Aggregate Bond Index includes investment-grade U.S. government and corporate bonds, mortgage pass-through securities, and asset-backed securities.
Emerging-market bonds are debt instruments issued by developing countries.
The federal funds rate is the interest rate that banks charge each other to borrow or lend excess reserves overnight
Floating-rate loans (or bank loans) are financial instruments that pays a variable or floating interest rate. A floating-rate fund invests in bonds and debt instruments whose interest payments fluctuate with an underlying interest-rate level.
A global bond is a type of bond issued and traded outside the country where the currency of the bond is denominated.
High-yield bonds are represented by Bloomberg US Corporate High-Yield Index, which measures the USD-denominated, high-yield, fixed-rate corporate bond market.
Investment grade refers to the quality of a company's credit. To be considered an investment-grade issue, the company must be rated at "BBB" or higher by Standard and Poor's or Moody's.
Mortgaged-backed securities (MBS) are bonds secured by home and other real estate loans.
Pacific Asset Management LLC is the sub-adviser for the Pacific Funds Fixed Income Funds. The views in this commentary as of the publication date and are presented for informational purposes only. These views should not be construed as investment advice, an endorsement of any security, mutual fund, sector or index, or to predict performance of any investment. The opinions expressed herein are subject to change without notice as market and other conditions warrant. Any performance data quoted represents past performance which does not guarantee future results. Any forward-looking statements are not guaranteed. All material is compiled from sources believed to be reliable, but accuracy cannot be guaranteed. Sector names in this commentary are provided by the Funds’ portfolio managers and could be different if provided by a third party.
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