Floating rate loan fund makes the case for consistent income

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When Andrew Sveen started a training program at State Street Bank in Boston in the 1990s, he wasn’t sure where it would lead.

The training, he recalls, covered “good fundamental credit analysis and learning how to tear up balance sheets”.

Years later, tearing down corporate balance sheets is still important to Sveen, who now leads the variable rates team at Boston-based asset manager Eaton Vance, his employer since 1999.

“We love what we do,” says Sveen, 53, who brings many years of experience in dealing with these loans. “We come every day, it’s a headache, and we have to look at all these different businesses and make investments.”

The pieces of this particular puzzle are floating rate loans, which are bank loans that have junk status and whose yields reset periodically based on the London Interbank Offered Rate, or Libor, a benchmark that is being phased out and replaced by Sofr, or the overnight guaranteed rate. financing rate.

Sveen oversees approximately $40 billion of various institutional and retail products across the company’s floating rate loan offerings, a longtime area of ​​expertise for the asset manager.

Issued by companies in many industries, floating rate bank loans are relatively short-term instruments, with an average life of about three years, say Sveen and Craig Russ, another floating rate portfolio manager. Typical scenarios for companies needing this funding, they add, include merger and acquisition deals that require funding or a private equity firm taking on a private company.

Two of the team’s top retail portfolios are the $9 billion


Eaton Vance Advantage Variable Rate

funds (ticker: EAFAX) and the $8.4 billion


Variable Rate Eaton Vance

(EVBLX). A key difference for the Advantage fund is that it uses leverage to buy more income-generating assets. That has helped give it a performance edge, with a recent three-year annual return of 3.82%, putting it in the top 25% of the Morningstar bank loan category. It also outperformed its category over the one-, three-, and five-year periods, according to Morningstar.

Although the leverage of the Advantage fund “can lead to outsized losses during heavy selling,” the fund managers are committed to “careful credit selection and vigilant risk management,” according to Morningstar.

The Advantage fund has a 12-month return of 3.78%, according to Morningstar, compared to 3.05% for the other fund. Advantage fund A shares have an expense ratio of 1.6%, below the average for its category. However, the vast majority of the fund’s investor base is in institutional share classes, including EIFAX, which has an adjusted expense ratio of 0.75%.

Sveen, Russ and their colleagues typically make small bets on hundreds of holdings and avoid large concentrations of individual loans. These loans are split, allowing investors to hold smaller chunks of an issue, not the entire loan. As of December 31, for example, the fund held loans issued by around 540 companies.

“The key is that your investors know what they’re getting, and if so, they want nice, consistent income,” says Sveen. Russ notes that the average Libor spread for the team’s holdings is 3.5%, generally staying in the 3% to 4% range.

Full return
1 year 3 years 5 years
EAFAX 3.0% 3.8% 3.8%
Bank loan category 2.7 3.2 3.1
Top 10 issuers % actives
Numerical group 1.12%
Blank media 0.89
Transdigm 0.82
Banff Merger 0.80
Carnival 0.78
Ziggo 0.78
Ultimate Software Group 0.75
Magenta Buyer 0.72
CenturyLink 0.70
Universal Ally 0.70
Total: 8.06%

Note: holdings as of December 31. Returns through February 15; three- and five-year returns are annualized.

Sources: Eaton Vance; the morning star

Sveen worked for many years with Russ, 58, who plans to retire in June after 25 years at Eaton Vance and a long career in bank loan investing. Russ was appointed as Co-Head of the Floating Rate Loans team in 2014. Sveen became his Co-Head in 2019 and now leads the Floating Rate Loans group only as Russ prepares to retire.

Another distinguishing feature of floating rate loans is that they are secured by the assets of the issuer, unlike most high yield bonds. These assets could include receivables, inventory, property, and intangible assets like copyrights, essentially downside protection if a business goes bankrupt. Another attractive feature is that these loans enjoy senior status at the top of a company’s capital structure, meaning loan investors would be paid before, say, common stock holders.

Most of these loans have recently been trading around par as investors have raised prices in a hunt for yield, Russ and Sveen say. They rebounded after a massive sell-off at the start of the pandemic nearly two years ago.

When a loan is trading near par, it means that almost all of the return comes from coupon, not capital appreciation. By contrast, for many other bond investors and money managers, the specter of higher interest rates — the Federal Reserve has said it plans to raise short-term rates in the near future — is worrisome. Bond prices and yields move in opposite directions.

“We don’t have that interest rate risk tied to the value of our holdings,” says Sveen.

As of December 31, holdings in the two floating rate funds included loans issued by the cruise line


Carnival (CCL)
,


TransDigm Group

(TDG) and Ultimate Software.

Carnival’s loans, two of which the team holds with a 4% coupon, are not typical holdings for the floating rate loan group. That’s because they served effectively as emergency funding – Carnival and other cruise lines became cash-strapped during the pandemic after being banned from leaving US ports for 15 months from March. 2020. Sveen and his team were reassured, however, that Carnival’s loans were secured by ships in its fleet. More recently, cruise lines have shown signs of progress.

Ultimate Software provides human capital management software and its team-owned loans carry coupons of 3.75% and 3.85%. “The beauty of software is in its recurring revenue nature,” says Russ.

Meanwhile, TransDigm – a maker of aerospace components such as ignition systems, pumps and valves – has “very repeatable business,” given the predictable nature of its business and strong market share. The two largest variable rate loans held by the team have coupons of 2.35%.

Write to Lawrence C. Strauss at [email protected]

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