T Rowe Price (NASDAQ-GS: TROW) has introduced a Floating Rate Fund (PRFRX) for individual investors. The new no-load mutual fund represents a second addition to T Rowe Price’s lineup of bond fund offerings this year, following the launch of the Emerging Markets Local Currency Bond Fund (PRELX).
Seeking high income, the T Rowe Price Floating Rate Fund offers long-term investors potentially attractive yields and some protection against interest rate risk by investing in loans to below investment-grade companies.
According to a Forrester Research Inc. survey commissioned by T Rowe Price in the second quarter of 2011, 56 per cent of investors do not understand the inverse relationship between bond prices and interest rates — that is, when rates rise, bond prices fall and vice versa.
"Investors need to have well-informed expectations of their bond portfolios, so they can invest appropriately for their time horizon," says Stuart Ritter, a certified financial planner with T Rowe Price. "They should understand that their bond holdings do come with particular risks, one of them being interest rate risk. The Floating Rate Fund has more credit risk than a fund investing in investment-grade securities, but it also can be used to manage interest rate risk and provide higher yields." (Credit risk pertains to a bond issuer’s ability to make timely payments on debt obligations).
The Floating Rate Fund invests in floating rate loans or leveraged loans, which have interest rates that reset either quarterly or monthly, usually to a certain per centage above the London Interbank Offered Rate or LIBOR. These loans are arranged or syndicated by banks for companies that usually have a significant level of debt relative to equity and whose loans are rated below investment grade in terms of creditworthiness. Often, the loans are used for recapitalisations, acquisitions, leveraged buyouts, and refinancings.
Many floating rate loans also have a LIBOR floor, which means they pay a certain interest rate even if LIBOR falls. In today’s low interest rate environment, LIBOR floors can be especially attractive as they could provide better current income than comparable loans without floors. As of July 31, 2011, about 47 per cent of the loans in the Floating Rate Fund have a LIBOR floor.
T Rowe Price manages USD2.2 billion in floating rate strategies as of June 30, 2011, and has managed the Institutional Floating Rate Fund (RPIFX) for advisors and institutional investors since its launch in 2008. Co-managers Justin Gerbereux and Paul Massaro, who manage the Institutional Floating Rate Fund, also will bring their experience to managing the new Floating Rate Fund for individual investors.
"The Floating Rate Fund not only offers higher yields and some defence against interest rate risk, but allows investors to participate in a gradually improving corporate America," says Gerbereux. "That said, I want to remind investors that this fund should not replace low-risk bond investments in a diversified portfolio, as it is a sub investment-grade asset class. However, loans usually are at the top of the capital structure, which means that they are among the first to be paid in the event of a default."
The minimum initial investment in Floating Rate Fund is USD2,500 or USD1,000 for retirement plans or gifts or transfers to minors (UGMA/UTMA) accounts. The net expense ratio is estimated to be 0.85%.
