With the bank loan fund marketplace maturing and expanding, advisers appear to now be willing to launch open-end bank loans funds that offer investors something they have never had before - daily redemptions. Up until now, quarterly, or at best, monthly redemptions had been the only option.
In recent weeks, Fidelity Investments and Eaton Vance Corp., both of Boston, have launched the fund industry's first open-end floating rate bank loan funds.
On Aug. 23, Fidelity announced the introduction of the Fidelity Advisor Floating Rate High Income Fund, the first dedicated floating rate fund Fidelity has offered and the first fund of its kind to allow daily redemptions.
Three weeks later, on Sept. 14, Eaton Vance announced it would be introducing the open-end Eaton Vance Floating-Rate High Income Fund which would also offer daily redemptions. Eaton Vance currently offers five other floating rate bank loan funds, including the Eaton Vance Prime Rate Reserves and the EV Classic Senior Floating-Rate Fund. But both offer only quarterly redemptions.
Once considered an illiquid market, bank loan fund sponsors have traditionally offered investors limited redemption options. Historically, fund companies have either structured their bank loan funds as closed-end funds whose shares are traded in a secondary market on a stock exchange or as "interval" funds. Shares of interval funds can be purchased daily, but only offer quarterly redemption windows during which investors can tender, up to a certain limit, their shares.
Only one fund, the CypressTree Senior Floating Rate Fund, has offered investors monthly redemptions on the last business day of each month.
The earliest bank loan funds, such as the Pilgrim Prime Rate Trust, managed by Pilgrim Investments, now a unit of ING of the Netherlands, was introduced in the late 1980s. Eaton Vance also introduced a senior floating rate fund at that time.
Now several fund advisers offer bank loan funds and most have come to market in the past couple of years. Sponsors now include AIM Management of Houston, Franklin Templeton of San Mateo, Calif., OppenheimerFunds of New York, Liberty Stein Roe and John Nuveen & Co. of Chicago, Van Kampen of Oakbrook Terrace, Ill. and CypressTree Investment Management of Boston, which was acquired by American General Corp. of Houston last year.
Bank loan funds invest in domestic and foreign loans that banks, bank syndicates and other financial services organizations make to corporations to finance expansions, restructurings, leveraged buyouts or other acquisitions.
These bank loans are usually collateralized by a company's inventory or other tangible assets such as warehouses, buildings or other real estate. Consequently, they are called "secured" loans.
These bank loans are also considered "senior" in that they have pay back priority over other debt or equity instruments a corporation may issue.
The loans have floating rates of return which are reset periodically over the short-term, according to changes in interest rates. The rates are tied to changes in either the Prime Rate or the London Interbank Offered Rate (LIBOR.) Because rates are reset often, bank loan funds tend to mitigate the interest rate risk associated with other bond funds.
"The introduction of (the) Eaton Vance Floating-Rate High Income Fund, with its daily liquidity feature, signals the coming of age of the bank loan asset class," said James B. Hawkes, chairman and CEO of Eaton Vance Corp. in a statement.
Greater supply and demand are producing the increased liquidity which means advisors are increasingly willing to offer daily redemptions, said portfolio managers.
"These are not ultra liquid, but sufficiently liquid to offer as a daily fund," said Scott Page, vice president and portfolio manager at Eaton Vance.
The size of the bank loan market has grown dramatically, said Christine McConnell, portfolio manager of the new Fidelity Advisor Floating Rate High Income Fund. While new issues in the bank loan market accounted for about $81 billion in 1994, in 1999 the marketplace of new issues jumped to $320 billion.
"We're going through a period of change in capital markets," said Page. The whole bank loan market is changing the way companies finance themselves he said.
In addition, the bank loan market has seen a surge of additional investors fueled in large part by a significant decrease in the minimum investment required to be a participant, from $15 million to $1 million said McConnell. She said that in 1994 only 18 institutional investors were bank loan product buyers. But by last year, that number had soared to 67.
Eaton Vance estimates that retail investments in the bank loan asset class are now $35 billion. And, the secondary market infrastructure is now in place allowing advisors to offer daily redemptions, said McConnell.
In response to concern among regulators earlier this year regarding how these semi-illiquid bank loans were being priced by mutual fund companies, Van Kampen and other fund companies increased their vigilance on pricing loans and many began using the services of Loan Pricing Corp., an independent pricing service bureau in New York. Both Fidelity and Eaton Vance are using Loan Pricing so that each of their bank loans can be priced daily.
Despite the maturation of the bank loan market, liquidity is still an issue, said one floating rate portfolio manager who questioned the wisdom of fund companies' now offering open-end bank loan funds.
"The market is becoming very liquid, but it is still not ready for this," said the manager.
Moreover, the daily pricing fund companies have to adhere to in order to offer daily redemptions is likely to increase the fund's share price volatility, he said. That goes against the very nature of bank loan funds whose core benefit to investors has traditionally been the low volatility in share price, he said.
Furthermore, bank loan funds that offer daily or even monthly redemptions may be sacrificing some return on investments because they have to sideline a percentage of funds' assets as a cash cushion to realize more frequent redemptions, said the manager.
While Fidelity can, by prospectus mandate, keep up to 35 percent of the fund in short-term investments that are easily convertible into cash, it expects to maintain a 20 percent cash position. According to Page at Eaton Vance, the new open-end Eaton Vance floating rate fund has no such cash equivalent requirement.
Other fund sponsors are taking a wait and see approach to offering open-end bank loan funds.
"We think there's a lot more volatility and less yield [in open-end funds]," said one fund company spokesperson.
