Beat Rising Rates with Floating Income

By Lee Bellinger / December 23, 2015

The threat of recession looms in the early goings of 2016 (see “Recession-Resistant Investments,” page 6). There’s a whiff of deflation in the air, too. But any deflation problem will likely be swiftly conquered by the Federal Reserve. Fed officials have zero tolerance for falling prices. They’re convinced that re-inflating by any means necessary is part of their job description.

Therefore, longer-term inflation is the likely outcome of any trouble in the economy. We will eventually see higher inflation and higher interest rates. It’s just a matter of when. And when that unpleasant combination comes about, conventional fixed-rate bonds won’t be where you want to have a lot of capital parked.

The Fed wants to be able to raise its benchmark Federal Funds rate steadily in 2016, until it reaches more normal levels. If that happens, then bond yields and loan rates could also start rising toward more normal levels.

Variable-rate loans to corporations, sometimes called “senior loans,” and often called “floating income” by investors, are available through specialty mutual funds and closed-end funds. Securitized bank loans make it possible to profit directly from the interest payments banks receive. The advantages of floating income are higher rates of return than government bonds and the potential for yields to rise as loan interest rates rise.

The potential disadvantage is that senior loans are more economically sensitive than government bonds. Floating-income instruments took a big hit during the financial meltdown of 2008. They also slumped toward the end of 2015.

One way to enjoy some floating income is with the Eaton Vance Floating-Rate Income Trust (EFT). This closed-end fund currently yields 7.5% and trades at a 14.4% discount to net asset value.

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