Interest rates are falling. “Why are investors interested in these floating rate securities?” asks Ashok Bhatia, co-CIO – Fixed Income; Brad Tank, Global Head and Co-CIO – Fixed Income and Joseph P. Lynch, Senior Portfolio Manager and Global Head of Non-Investment Grade Credit for Neuberger Berman. The Fed has just cut interest rates twice as much as expected. In November, the federal funds rate is expected to decrease a second time by 50 basis points (0.5%), if the market is to be believed.
“We anticipate two further reductions of 25 basis points (0.25%) this year. Furthermore, we have seen a significant increase in customer demand for variable rate investments, both senior loans , private credits or different tranches of CLOs (collateralized loan obligations)”, these specialists report.
Rates are falling, but investors are fond of floating rates.
According to the asset manager, “one explanation is that, although rates are falling, very few people believe that we are on the path to a return to the zero rates and flat yield curves of the years before the pandemic and following the global financial crisis Indeed, we believe that the rate markets are too pessimistic about US growth and that the Fed will reduce its rates less significantly and more gradually than investors expect.
However, for the management company, “even if you share the market sentiment and prepare for a neutral long-term rate of around 2.75% to 3.25%, the variable rate returns” all-in” would remain relatively attractive. Additionally, you would start with wider spreads than equivalently rated fixed rate bonds, due to the liquidity premiums, complexity and “lack of familiarity” that remain associated with some variable rate markets.
These premiums act as a buffer of sorts for floating “all-in” returns as their risk-free benchmark rates decline.
