Last Friday’s unemployment data sparked all kinds of politically heated debate about the economy. I encourage you to tune it out and simply get a solid understanding of certain investment themes that are likely to get you through the next cycle. Earnings from interest are an interesting place to start. So, let’s get interested:
Since the 2008 recession, credit risk has declined. This is evidenced by default rates that are below long-term averages, an increase in issuance of bonds and rising demand for them. Corporate balance sheets are quite healthy too. The risk facing the fixed income market now is interest rate risk. Rates will rise. The only question is when. Floating rate securities may help investors manage this risk.
Things to know about the floating rate or bank loan market:
Interest paid on these securites is tied to a market rate and usually keeps up with changes in a rising rate environment.
Bank loans are typically the top of the food chain. They are most always secured by liens on assets of the issuer.
Due to the fact that they historically have low correlation to other fixed income securities, they may add to a portfolio’s overall diversification.
Income investors looking to reduce interest rate risk should understand this class of fixed income securities.
Investment performance is often measured by comparing it to an index that is representative of similar holdings. Here are a few that you should understand:
Standard & Poor’s (S&P) 500 Index – is an unmanaged index that tracks the performance of 500 widely held, large-capitalization U.S. stocks.
Barclays Capital Aggregate Bond Index – is a market-value-weighted index that tracks the daily price, coupon, pay-downs, and total performance of fixed-rate, publicly placed, dollar-denominated, and nonconvertible investment grade debt issues.
London Interbank Offered Rate (LIBOR) – is the rate at which an individual Contributor Panel bank could borrow funds, were it to do so by asking for and then accepting inter-bank offers in reasonable market size just prior to 11.00 London time. (Many mortgage products are tied to this rate.)
~Columbia Management contributed much of this data.