When interest rates rise, a bond’s market value often goes down. This is because the bond’s rate can be fixed and can’t compete with the rates offered by newer issued bonds. If this situation arises, the bond might sell at a discount. Such declines can be unsettling for owners of bond mutual funds, since the value of the fund can sometimes drop with these rate increases. So where does that leave you, if you are seeking an income stream that keeps pace with prevailing interest rates but without the radical drop in principal? Consider bank-loan mutual funds.
Bank-loan mutual funds typically hold baskets of short-term loans issued by banks and other financial institutions. These loans are often made to companies for financing leveraged buyouts and restructuring activities.
The loans are usually secured by the assets of the borrowing companies. The interest paid on these loans is often tied to a certain benchmark lending rates, such as the London-Interbank Offered Rate (LIBOR) which adjusts every 30 to 60 days. Therefore, as the market rates change, the monthly interest payments to the fund companies can change as well. Because of the changing interest on the underlying business loans, the values of the fund shares tend to be less affected by interest rate fluctuations in the economy.
There are, however, some risks that need to be considered. For example, some bank-loan funds are dominated by non-investment grade quality issues. This means that the underlying loans are made to companies that have lower financial stability. And they may have ratings, such as a BB or lower on the Standard & Poor’s bond-rating scale. The loans to these companies can have a greater risk of default, but as secured loans, they are often given priority for repayment; although the assets collateralized aren’t always enough to completely compensate the loan holders.
Bank loan funds are mutual fund investments that involve risk and are offered by prospectus only. Investment return and principal value will fluctuate so that upon redemption an investor’s shares may be worth more or less than original value. An investor should carefully consider the investment objectives, risks, charges and expenses of a fund prior to investing. The fund prospectus contains this and other information about the investment company. For a copy of the prospectus, you should contact your financial advisor. You should also read the prospectus carefully prior to investing money.

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