Brokers and financial advisers are recommending higher yielding “floating rate” funds to investors seeking more yield in the current low yield environment, but, for a number of reasons, regulators are warning that these investments are risky.
According to Sarah Morgan’s SmartMoney.com article entitled “Are ‘Floating-Rate’ Funds Safe?”, floating rate funds offer yields of 6% or better, more than most bond funds, stock dividend funds, and REITs. In fact, investors have over $63 billion invested in such funds, $22 billion in net inflows this year alone. Eight new floating rate funds have been started this year. The category has quadrupled since 2008, when the average floating rate fund lost 30%, then gained 42% in 2009.
The Financial Industry Regulatory Authority (FINRA) has warned that the funds offer higher yields because they have higher risk. Floating rate funds basically invest in higher-risk bank loans made to companies with below-investment-grade credit ratings. They do not trade on an exchange and are relatively illiquid and difficult to price.
“These are equivalent to junk bonds in terms of their credit rating,” Sarah Bush, a fund analyst with Morningstar, was quoted as saying. But Jeff Tjornehoj, a senior analyst for fund research company Lipper, notes, “when you use that ‘junk’ term instead, people become a bit more cautious.”
Brokers and financial advisors emphasize the high yield aspect of the investment because high yield sells. They also sell the floating rate funds with the promise of protection against rising interest rates. But when the Federal Reserve indicated that rates would be kept low for another two years, investors who bought them for that reason are now thinking they do not need them anymore.
Simply stated, floating rate funds are another “alternative investment” that is more complicated and risky than investors have been led to believe.
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