What About That Other Kind of Floating-Rate Loan Fund?

Readers of this column, it seems, can't get enough information about closed-end floating-rate loan funds, a topic covered most recently in the June 4 Fixed-Income Forum.

That column focused on the four exchange-traded funds: Eaton Vance Senior Income Trust (EVF Quote), Pilgrim Prime Rate Trust (PPR Quote), Travelers Corporate Loan Fund (TLI Quote) and Van Kampen Senior Income Trust (VVR Quote). It mentioned in passing that there's another type of floating-rate fund -- the so-called continuously offered variety -- of which there are 15.

Reader Len Krauss wants to know more: names, symbols, expense ratios, and so on.

First, a brief review: Floating-rate loan funds invest in loans to speculative-grade corporations. The loans are ideal for packaging in closed-end funds because they are relatively illiquid. There are no open-end corporate loan funds because they could have problems meeting redemptions on a daily basis.

The asset class is less risky than high-yield bond funds -- even though the same type of company issues high-yield bonds as takes out the loans in which the funds invest. Why? First, because loans get paid before bondholders. Second, because high-yield bonds are fixed-rate instruments, so if interest rates rise, the prices of the bonds will fall. With floating-rate funds, when interest rates rise, the interest rates on the loans float higher, keeping the prices (and therefore the fund net asset values) stable. (The risk, of course, is that interest rates will fall.)

The combination of a relatively high yield with immunity from interest-rate risk has enabled the funds to post pretty consistent returns. From 1994 to 1998, according to Lipper, the lowest average total return for the category was 6.49% last year, while the highest was 8.25% in 1995.

The continuously offered floating-rate loan funds have more in common with open-end funds than with closed-end funds. The shares don't trade on an exchange, and you can buy new shares any day at net asset value.

But as Lipper closed-end fund analyst Don Cassidy points out, the definition of a closed-end fund is not that it trades on an exchange, but that it doesn't redeem shares daily, and these funds don't. In most cases you can redeem your shares only once a quarter. A few funds offer monthly redemption.

The relative merits of exchange-traded and continuously offered floating-rate loan funds are pretty simple. An exchange-traded vehicle never needs to meet redemptions, so it can stay fully invested at all times, a situation that should enable it to post a higher yield. (Pilgrim Prime Rate Trust, which until last year was the only exchange-traded floating-rate loan fund, has consistently posted bigger numbers than its continuously offered counterparts.) But an exchange-traded vehicle can also trade at a discount. With a continuously offered fund, you get out at NAV, never less.

Unfortunately, it's tough to get information about the continuously offered funds. Most have five-letter ticker symbols, but because they're not open-end funds, most ticker services don't gather data on them. And because they're not exchange-traded, their numbers don't appear in newspaper closed-end fund tables.

Fortunately, the information can be found out, and I've dug it up. View this table for a complete list of continuously offered floating-rate loan funds.

You'll notice there are only a couple of pure no-loads, but luckily, they appear to be the best of the bunch, at least in terms of their expense ratios (a huge determinant of performance in the income arena) and recent performance. Stein Roe should be easy to find; CypressTree is available through a number of fund supermarkets (though not Charles Schwab) or directly from the company, at 800-876-5957.

EVF's Manager Responds

The June 4 column included the view that EVF should be considered separately from the other three exchange-traded closed-end funds since up to 10% of its assets can be invested in high-yield bonds, fixed-rate instruments that make the fund more volatile.

I ought to have given Scott Page, the fund's co-manager, an opportunity to respond, which he did in a recent email:

"It is true that EVF invests 10% in high-yield, but the additional volatility this may add hardly qualifies it to be considered apart from [the other three funds]. Last fall, in the worst junk bond market since [1989-90], high yield fell approximately 10% (from which it has since recovered). Ten percent of 10% is 1%, or 10 cents of NAV, 15 cents if we are fully leveraged. That hardly qualifies as a separate class of funds. It also allows us to take a less aggressive posture on the 90% of the portfolio that is floating-rate bank loans, while still delivering a strong yield."

The addition of high-yield bonds to a tenth of the portfolio, Page added, extends its duration from about 50 days to about 230 days. "Not really that much interest-rate risk."

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