Interest rates are now at historic lows, but it’s never too early to prepare for those rates to rise, according to Robert Dial, manager of the $834 million MainStay Floating Rate Fund Ticker:(MXFAX).
“I don’t think the Fed is going to tighten [the money supply] in the next couple of months, but in terms of timing this is a pretty opportune time [to start hedging the risks associated with rising rates],” he said.
As the manager of a mutual fund which invests in floating-rate bank loans, Mr. Dial is essentially always offering a hedge against rising interest rates.
In a rising interest-rate environment, the net asset value of fixed-rate bonds, particularly longer-term bonds, typically declines. But floating rate corporate bank loans that are pegged to the London Interbank Offered Rate can benefit as interest rates on the bonds has a tendency to follow the
Federal Reserve Board’s monetary policies.
“This fund is a natural hedge against rising rates, and we think the strategy is the most direct way to benefit from a rising rate environment,” Mr. Dial said.
He and his team manage the fund through the fixed-income group at New York Life Investments, a company with more than $263 billion under management.
In constructing the portfolio, credit quality often leads the process.
The loans are always below investment grade, because investment-grade companies typically won’t need to go to a bank to raise assets.
For that reason, the borrowing companies are the same companies issuing high-yield bonds.
Mr. Dial is slightly overweight double-B rated loans, and slightly underweight triple-C rated loans. He has also added some high-yield bonds to the portfolio as a way to enhance performance.
The reason to maintain this kind of exposure ahead of rising rates is that when a rate hike is anticipated, bond prices will start adjusting ahead of the actual Fed decision.
But Fed policy isn’t the only thing that has an impact on LIBOR, as was illustrated over the past six weeks when the LIBOR rate climbed to 54 basis points from 20 basis points, largely as part of the fallout from the European debt crisis.
The MainStay Floating Rate Fund has lagged behind its benchmark, the
Credit Suisse Leveraged Loan Index, over the past year as riskier bonds have outperformed.
This year though May, the fund gained 2.8%, while the benchmark gained 3.5%.
But on a three-year annualized basis, the fund gained 2% while the index gained 1.8%.
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