With the rise in LIBOR occurring at the same time as overall yields remain low, investors should be looking at shifting some of their fixed income investments into floating rate assets.
We are seeing a relatively uncommon event in the high yield bond and leveraged loan markets.
HYG Dividend Yield versus BKLN Dividend Yield
The dividend yield of HYG and JNK (and high yield funds in general) are converging with the yields on BKLN (and leveraged loan funds in general).
This is particularly interesting to me because
If the Fed finally follows through and delivers a second rate hike, LIBOR should go above 1%, increasing the relative value of floating rate assets, while fixed rate assets could weaken
If the economy turns out to be fragile, LIBOR should remain elevated, and you have, as a broad generalization, moved up the capital structure since leveraged loans tend to be senior secured borrowing and high yield bonds are generally senior unsecured
While it may not be a ‘win/win’ situation I think the risk reward right now is in favor of taking profits in high yield funds and moving to leveraged loan funds.
Alternative ways to participate
Many closed end loan funds continue to trade at a significant discount to NAV, providing additional total return potential, and the inherent leverage in some funds is less a concern as both the asset and liability side are floating rate (for full disclosure I own several closed end loan funds – including in my retirement accounts)
Floating rate bond funds. While an ETF like FLOT has a far lower yield than LQD, the yield should increase over time as more of the underlying bonds reset. You have far less duration risk both from a rate risk and a credit risk standpoint. The yield differential might be too large for you, but I think it is worth examining your tolerance to price volatility related to interest rates and credit spreads at this time before finalizing that decision.
There are some ‘alt’ funds specializing in structured credit which could be interesting – though the underlying liquidity significantly increases the risk along with the reward.
From an income perspective, floating rate assets deserve some attention in your ‘fixed income’ portfolio.