Floating-Rate Funds: Still Relevant for Investors’ Diversification?
February 25, 2020 — London
Outlook on interest rates could have little effect on popularity of such funds, but other options may hold greater appeal for European investors
Floating-rate credit funds could remain an effective diversification vehicle, despite some disappointing performances in the past few years and little prospect of the world’s main central banks increasing interest rates in the near term, according to findings from the latest issue of The Cerulli Edge—European Monthly Product Trends. Although floating-rate notes generally benefit from a rising-interest-rate environment, they are also appealing to investors in a low-interest-rate world, making them a versatile option, says Cerulli Associates.
“Typically, floating-rate notes are less volatile than other types of bonds due to their ability to more accurately reflect interest rates, as the coupon on these notes is ‘floating,’ which means it resets in line with the reference rate, whether that is the London Interbank Offered Rate (LIBOR) or U.S. Treasury securities, for instance,” says Fabrizio Zumbo, associate director of European asset management research at Cerulli.
Floating-rate credit funds generally struggled over the one- and three-year periods to the end of January 2020. But, for the moment at least, many products are sustained by stronger performance at the earlier stages of their five- and 10-year track records. Nevertheless, some floating-rate credit funds have struggled to attract inflows, forcing their closure.
One potential challenge for the funds is the discontinuation of LIBOR at the end of 2021. After several well documented scandals, the Bank of England (BoE) has stated that LIBOR is “no longer a reliable benchmark” for interest rates.
Users of LIBOR, including issuers of floating-rate notes, will be expected to switch to alternative benchmarks. In a statement published in September 2019, the bank said that in sterling markets, the primary alternative is SONIA, the Sterling Overnight Interbank Average Rate, administrated by the BoE and based on an average of more than £40 billion (US$51 billion) of daily transactions. New issues of long-dated floating-rate notes have found alternative options, but plenty have not yet moved away from LIBOR, leaving some bondholders potentially at risk.
Zumbo says that investors seeking an alternative to floating-rate credit funds might consider strategic bond funds, which can invest across the spectrum of fixed-income securities. “Most asset managers offer a strategic bond fund, meaning there may be more choice than the rather limited number of floating-rate note funds on offer,” he notes.
- The alternative fund industry suffered net outflows of €1.4 billion (US$1.5 billion) in December, to take total net outflows for the year to €33.5 billion, notes Cerulli. The sector's total assets under management (AUM) stood at €332.7 billion at the end of 2019, 2.1% less than its AUM at the end of 2018. Equity alternative market long/short, equity alternative market neutral, derivatives, and funds of hedge funds were responsible for much of 2019's loss, registering collective net outflows of €34 billion. On the plus side, equities infrastructure recorded net inflows of €3.3 billion.
- Having suffered outflows during the first four months of 2019, the cross-border market enjoyed inflows for the remainder of the year, says Cerulli. In December, cross-border funds registered €24.9 billion in net new money, taking the annual total inflows to €143.0 billion. Bonds and money markets were the key drivers of inflows in 2019 as investors adopted a risk-off approach, with fixed-income funds attracting net inflows of €149.8 billion and money markets €60.9 billion during the year. The hardest-hit sector was equity funds, which recorded outflows of €49.4 billion in 2019. However, global equity funds gathered €1.4 billion in December and €17.5 billion during the year.