Bank loans no cure-all for rising interest rates

No bond sector has been hotter than bank loans this year, but investors who are loading up on them to protect against rising interest rates may be disappointed. Bank loan mutual funds had more than $19 billion in net inflows this year through the end of April, the most of any bond fund category and up from $1.26 billion a year earlier, according to Morningstar Inc. The loans have become popular thanks to their floating rates, which typically are tied to benchmarks such as the London Interbank Offered Rate. The only problem is that those benchmarks are tied to short-term rates, while the market is being driven by long-term rates, said Kathy Jones, a fixed-income strategist at The Charles Schwab Corp. “Bank loans aren't necessarily a bad idea, but they're not going to deliver the returns people are hoping for until short-term rates go up,” she said. “They're not going to get a lot of benefit from long-term rates rising.”

UPWARD JUMP

Last month, long-term rates skyrocketed 25% to 2.13%, from 1.66% at the beginning of the month, as investors worried about the Federal Reserve slowing down its asset-purchasing program this year. The violent jerk upward caused losses across every bond fund category tracked by Morningstar except bank loans, which finished the month virtually flat.

HIGH YIELDS

The outperformance, however, is largely thanks to their relatively high yields and the fact that they are short-term bonds, which are not as sensitive to rising rates, Ms. Jones said. “Bank loans may not hurt you, but they may not help, either,” she said. “We don't want people to be disappointed.” Bank loans won't see a benefit from rising rates until the Fed starts moving short-term interest rates, which it has kept near zero since 2008. Such a move is incredibly unlikely as long as quantitative easing is still going on, Ms. Jones said.