By Tom Bradley
In a Globe and Mail column on May 8th, I talked about how investors have been moving from defense to offense in their fixed income portfolios. Indeed, many of the new income funds and structured products are aggressive enough, and/or complex enough, that they fit better on the equity side of a portfolio. They’re not suitable replacements for low-yielding GICs or bond ladders.
I recently got an email that brought this issue to life. It was promoting a new fund, the Renaissance Floating Rate Income Fund, which is designed for investors who are concerned about rising interest rates. It owns securities where the yield adjusts to changes in interest rates.
The fund carries a ‘Low/Medium’ risk rating and sounds pretty conservative (i.e. rate protection), but it’s far from it. While it eliminates the rate risk, it goes to town on the credit (default) risk.
The average credit rating for this fund is expected to be Single ‘B’, which is two full letters below investment grade (BBB). With a ‘B’ average, many of the 248 holdings will be either unrated or carry a rating with a ‘C’ in front of it.
- It would appear that most of the portfolio is invested in private loans, which are relatively (totally?) illiquid.
- For liquidity purposes, the fund holds a sliver of publicly-traded bonds, but they too are in the high-yield category.
- If interest rates go up, fund holders will receive a higher yield, but it will come with even higher credit risk - issuers will be forced to make higher interest payments. Fund holders better hope that any rate increase is the result of an improving economy and not an inflation scare. In the latter case, weak credits and floating rate loans can be a toxic combination.
Where does this fund fit in a portfolio? It doesn’t say anywhere in the fund profile or Fund Facts, but it should go squarely in the high risk bucket (definitely not ‘Low/Medium’). Don’t get me wrong - there’s nothing wrong with taking credit risk, or even aggressive credit risk as is the case here. But funds like this one are not replacements for a bond ladder or your grandmother’s Bell bonds.