To limit risks, consider one of the tamer bank loan funds. These emphasize bonds rated BB, the highest level in the below-investment grade universe. More aggressive loan funds focus on bonds that are rated B or lower.
The cautious funds have outperformed peers during downturns. A solid choice is Fidelity Floating Rate High Income (FFRHX). During the past five years, the fund returned 4.8% annually, outdoing 91% of peers. While the average fund in the category has only 40% of assets in loans that are rated BB or higher, Fidelity has 59% in the higher ranks. Besides emphasizing higher quality securities, portfolio manager Christine McConnell also prefers loans made to large companies, since they are less likely to default.
The cautious stance helped limit risk during the turmoil of 2008. While the average bank loan fund lost 29.7% for the year, Fidelity dropped 16.5%. McConnell concedes that her fund can lag during rallies when investors bid up prices of shaky securities. But she argues that the steady approach can excel over a full market cycle. "We want to at least match our competitors while taking much less risk," she says.
Another steady performer is Pioneer Floating Rate (FLARX), which has returned 4.4% annually during the past five years, surpassing 77% of peers. The fund has 62% of assets in securities that are rated BB or higher. Besides emphasizing higher-quality issues, portfolio manager Jonathan Sharkey aims to limit risk by holding loans that come with tight covenants. These permit investors to obtain more favorable terms if borrowers fail to perform as planned. "The covenants enable investors to recover more if borrowers run into trouble," says Sharkey.A fund that excelled in 2008 is RidgeWorth Seix Floating Rate High Income (SFRAX). During the past five years, the fund has returned 4.5% annually, outdoing 83% of peers. Lately portfolio manager George Goudelias has been shifting into BB loans. "Until there is a strong economic recovery, it is prudent to have a little more exposure to the better quality investments," says Goudelias.