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A senior floating rate fund is a type of investment vehicle which is focused on loans from financial institutions that offer floating interest rates. What this means is that the interest payments offered to investors will stay competitive with the prevailing interest rates in the market. Another benefit of this type of fund is the fact that the loans included are paid back before other debt obligations should there be some sort of default by the borrowers, meaning that fund investors have a good chance of regaining the majority of their capital. The drawbacks associated with a senior floating rate fund include high fees paid to fund managers and lack of liquidity.
Investors wishing to add a fixed-income aspect to their portfolios often do so by investing in bonds or bond funds. The main problem with bonds is that investors are often out of luck should the issuing institution default on its debt obligations, since other creditors would take precedence in the payback schedule. In addition, rising interest rates can affect the yield of a bond held by an investor. One alternative to bonds that solves some of these problems is a senior floating rate fund.
When an investor makes a capital commitment to a senior floating rate fund, that capital essentially buys packaged debt sold off by banks or other financial institutions. Since this debt is incurred by borrowers that aren't guaranteed to be investment grade institutions, there is the chance of default. Still, the fact that the loans are taken directly from banks and other lenders means that these borrowers must pay them back before any money owed to bondholders. In this way, the fund investors are partially protected from default.
One other main benefit of a senior floating rate fund is the interest rate protection it provides. When interest rates rise, the value of bonds held by investors fall because the market favors the new bonds with the higher rates. Floating rate funds avoid this problem because the interest paid on the debt is dependent upon some interest rate benchmark. If the benchmark rises, the borrowers must pay higher rates, which increase the value of the fund.
While a senior floating rate fund does hold many advantages for investors, there are some negative aspects to this investment security. Since the fund must be managed, management fees paid by investors can lessen the impact of any potential returns. In addition, the assets in floating rate funds can only be redeemed at certain intervals, meaning that investors looking to cash out in a hurry may have a difficult time doing so.
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