Investor Beware: Bank-Loan Funds are not Money Market Funds

Investor Beware: Bank-Loan Funds are not Money Market Funds

May 1, 2005

Investor Beware: Bank-Loan Funds are not Money Market Funds
The WSJ referred to bank loan funds as a safe haven that investors are buying to protect themselves from rising rates. Bad idea.

Yield-starved investors have stuffed about $4 billion this year into bank-loan mutual funds, also called senior-loan funds or loan-participation funds, in which funds buy short-term loans that banks and other lenders make to companies. That’s a nearly 10-fold increase from a year ago.

Many investors are even using bank-loan funds, which distribute payments monthly and are currently yielding as much as 7%, as a stand-in for sedate money-market accounts…The risk with bank-loan funds: They are generally noninvestment-grade debt, meaning they have ratings of double-B or lower on the Standard & Poor’s credit-rating scale. That is in the junk-bond neighborhood. While not terribly troubling in an improving economy, low-rated debt is more likely to default in a weak economy.

Based on recent conversations with friends of mine–the guys who are actually making these loans–there is less diligence being applied to leverage lending today that during the last drunken brawl we had in the late 1990s, and certainly less than is applied when issuing a junk bond. I see serious default risk down the road.

Moral of the story: If you have money that you want to keep as cash, rather than invest for long’term income and gains, keep it in a money market fund–a real one–collect the 2-3%, and relax. Funds that pay you 5, 6, or 7% are paying you for the risk you will lose some or all of your money.

JR

John Rutledge

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