Bank Loan Comparables

Some investment pros like to quote Morningstar Ratings as an objective measure of an investment’s performance.  The rating has come under criticism periodically since it has not really been a good predictor of future returns (  But, it still persists as the go-to measure to confirm or deny an investment manager’s investment decision.  I came across a new problem recently with the Morningstar system that bears attention.

I am a fan of diversified exposures to manage portfolio risks.  One of the fixed income asset classes I favor is the bank loan sector.  That sector is not without credit risk, and perhaps liquidity risk, if not properly managed, but it has been a valid long term performer to smooth return profiles.

Looking at the top performers in the Morningstar Bank Loan Category revealed an interesting fact.  A top performer over the past five years in that category, the Eaton Vance Floating Rate Advantage I mutual fund (EIFAX), produced a 5-year total return of 4.32% besting the average Bank Loan total return of 2.97% and Intermediate Core Bond total return of 2.88% garnering it a Morningstar 5-star rating.

Upon more research, however, I found that the fund has a large leverage component to boost returns that the adviser discloses on its website and Fact Sheets; but this point is nowhere to be seen on the Morningstar site.  Leverage, of course, adds risk to a portfolio and could produce magnified gains and losses if on the right or wrong side of the bet.

Without a full review of all the Bank Loan funds in that category, it is hard to say how many other funds in that category utilize leverage.  Consequently, it is an unfair comparison to lump all bank loan funds, those with and without leverage, together within a ratings framework.  Once again, buyer beware and know what you are buying and why.