In investors' epic search for yield, one strategy in particular has risen to the top this yearloan participation mutual funds and ETFs.
With net inflows to both products reaching over $23 billion this year (through May 8), they are the most popular draw in the fixed-income market. They've even outpaced emerging market equity funds and ETFs as the top attraction overall for the year. Although the strategies have been around for a long time, a combination of factorsincluding investor concerns about credit risk, interest-rate risk and general volatilityhave made them the belles of the ball in 2013.
Loan fundsalso known as senior loan, bank loan, syndicated loan, leveraged loan or floating-rate loan fundsare built on the concepts of seniority and collateral claims in a company's capital structure. In the event a company goes into bankruptcy, loan holders typically have the first claim on the assets, followed by bond holders, convertible security owners and preferred shareholders. Common stock owners (who often get short shrift) rank at the bottom of the list. This order of claims preference is important in the loan market; companies that issue loans are generally not investment grade, otherwise they would issue commercial paper (a common ingredient in money market fund portfolios).
Because these companies aren't investment grade, they may also issue junk bonds. However, they can get cheaper short-term financing through a floating-rate loan than they can with a bond. Floating-rate loans (the only type of loan that goes into loan participation funds) are frequently issued to fund buyouts (hence the common "leveraged loan" name) and also to fund general operating expenses, capital expenditures and especially refinancing.