Monday, January 6, 2014

Floating Rate Funds ( Fixed Income )

The SAMBX Prospectus explains that they mostly invest in senior notes, (loans to commercial enterprises). In the event of bankruptcy, senior notes tend to be near the head of the creditor line. Therefore, while the fund might lose some principal if a note fails, they should not lose everything as tends to be the case with stocks. There are still tons of gotchas so this is a very small part of the overall portfolio, but it has its place. Let's look at two charts, the first is a ten year comparing SAMBX and a fund that is based on US Treasury TIPS, (inflation protected bonds), VIPSX, 2007 - 2014.

Now, let's look at just one year with the same two funds. SAMBX looks a lot better against VIPSX. My thesis is that people are still discounting the potential of inflation.

I use SAMBX for two reasons, to manage volatility so I can sleep at night and also as a hedge against inflation. Now it is not clear to me that wither SAMBX or VIPSX can actually be a hedge against inflation. However, if people believe that they are and start buying these funds, that should increase demand and drive the price higher. If I can get lucky and the price goes up 20% and inflation is at 5%, then these really help. Let's do one last chart, to illustrate the volatility management piece. The new color, yellow is SPY, my proxy for the S&P 500. VIPSX doesn't drop as much in the great recession because most people expected the US Government which issues the TIPS bonds VIPSX is based on to survive. But in the great recession, there was real concern that companies might fail, which was not good for either SAMBX or SPY.

The SAMBX NAV as of:

4/28/14 9.02 Well, we wanted something to manage volatility :)
3/1/13   9.02
3/8/13   9.04
3/19/13 9.05
4/20/13 9.08
5/1/13  9.09 Woo Hoo feel the engine roar :)
5/17/13 9.10
6/13/13 9.01 Hmmm, time to buy more?
6/26/13 8.97
7/21/13 9.04 Kinda wish I had moved on 6/26/13 :) Oh well, I am still working so there is only so much time to do investments right now.
7/23/13 9.05
1/6/14   9.06 In the past 6 months this hedge against inflation is up by 1%, but my expense ratio is .6, before taxes and trade fees in investment is up .4%, beats a checking account I suppose.  And there is that cute little three cent dividend. We are going to stay the course.
1/24/14 9.09 Been 2 tough days for Mr. Market, so far SAMBX does not appear to be high correlated with stocks and that is always nice.
4/3/14   9.06

1/8/14 9.08  The Chicago Tribune just ran a story on floating rate funds, they mention:

Lets run a comparison against SAMBX, Google cannot locate PRFRX, so we will focus on SAMBX and FFRHX.

As it is easy to see they are highly correlated. The spread at December 2013 is kind of interesting.; can't wait to see where it leads.

1/10/15 8.75
That is not what I was hoping for there are two holes in my thesis. This strategy was to reduce volatility in basket Cs. It is not like it is swinging wildly, but I was expecting slower change. And of course I was hoping it would go up not down. This still correlates with FFRHX. No action required.

2/12/14 9.08

11/29/13 SAMBX is still at 9.05, but I am happy, it adds stability to the portfolio and gives me some protection against inflation. Realize there are NO signs of impending inflation, but when I can build a shield at a bargain, what is not to like.

Update 5/2/14 Fascinating article on the topic from
Update 4/20/13 I found this article from a year ago and he mentions PRFLX and EVBLX.
Return for 1 year, expense
PRFRX +2.00%     0.85%
EVBLX +2.25%    1.02% with a front load of 2.25% Yikes!
SAMBX +2.60%   0.62%
This March 2013 WSJ article reminds us there are risks ( thanks ) but people are considering this as a hedge against inflation (thanks again :). And they mention:
OOSAX  +2.18%   1.06% with a front load of 3.50%
RPIFX    +2.08%    .55% (sounds great, but the minimum investment is a million dollars, even if I had that to spend that would be a lot of eggs in one basket )
NOTE: return for the year is NOT adjusted for dividends, or it would sound higher.

How we got started with this 3/2/13

I was ending a phone call with Sean Fowler ( Edward Jones Auburn WA) and he mentioned that I should look into a fixed rate fund as a hedge against inflation.


This is a type of fixed income that can serve as a hedge against inflation, it is very common to see these rates float 2% ( or even more ) above the T-bill rate. They also have the potential to smooth out a portfolio. Take a look at this risk table from Google Finance dated March 8, 2013 for one fund SAMBX:

A negative Beta and a fairly high Alpha with an attractive Sharpe ratio is what I need a bit of right now. To be sure with a Beta of -0.24 it is very unlikely I will see gains ( or losses) of 5% in a single day, but it makes sense to me to try to build an overall portfolio that smoothes out some of the highs and lows. Why?

Mr. Market is Bi-Polar (Sidebar)

Just three months ago, we were being told the world is ending, not just the Mayan calendar ( it tells you something about human nature that this was the number one question people were asking NASA), but that we would all fall off the fiscal cliff in December 2012 and have a recession.

With apologies to Men in Black for taking them out of context:
Kay: There's always an Arquillian Battle Cruiser, or a Corillian Death Ray, or an intergalactic plague that is about to wipe out all life on this miserable little planet, and the only way these people can get on with their happy lives is that they DO NOT KNOW ABOUT IT!

In our case as retail investors trying to set up a retirement, we can know about it, but we can't let it get to us. Last week as the Dow Jones set new records, the doomspeakers were already lining up. Are they right, are they wrong? Heck if I know, but I know that investing from a spirit of fear leads to poverty fast. And yet I am a human being, I feel fear, I have intuition trying to help me invest, so starting to think about smoothing out the portfolio, seems to be a good plan. Less emotional input.

Back to Floating Rate Funds Thesis

They loan corporations money and require a premium on the interest. The interest rate floats based on some metric like the Libor.  Obviously, the performance of the fund is impacted by interest rates and Ben Bernanke has kept them as low as possible for a while. Therefore, the potential of these funds to go up when interest rates go up is fairly high.

There are a number of these funds, many are very expensive ( high cost expense ratio, the industry average is 1.21%), some are only available if you are invested in some sort of wealth management type of broker. Most are traded over the counter and you may be limited  in when you can retrieve your money, once a quarter, 15th of the month, that sort of thing, so this needs to be in the long term portfolio type of thinking.


The clearest explanation I have found is this Investment U article. It is well balanced and talks about the pros and cons. I have been looking for a couple of days and doing my homework and have decided that I would like to open a position in a floating rate fund.
I was down to five semi-finalists today: SAMBX, FLYRX, AFRIX, CSHIX and HFRZX. In the end I selected SAMBX, it is not the top performer in 2012, but the expense is 0.62% which is about half of the industry average.