Floating rate notes and senior loans are unique in that their yield is tied to a benchmark such as LIBOR, rather than being fixed. Loans are also higher on the capital structure than other unsecured obligations, and some even carry floors to insure you earn a respectable yield even if rates stay low. Their coupon rate typically resets every 90 days, resulting in a duration shorter than three months, Benzinga reported.

“While its interest-rate risk is low, its credit risk is high. Most of the fund’s assets are invested in below-investment-grade loans,” said Morningstar in a recent note. “As of February 2017, the average default rate from 2002 to 2017 for high-yield loans was 3.3 percent, according to JPMorgan and S&P. The minimum initial spread must be 125 basis points over Libor to be included in this fund. Thus, despite its short duration, the fund offered a yield of 2.7 percent in February 2017.”

“Senior loans’ illiquidity creates challenges for the fund. There is a liquidity mismatch because the fund must provide daily liquidity, while there is no set time limit to settle senior-loan trades. In fact, it took 17 days on average to complete a senior-loan trade during the second quarter of 2016, per Markit,” said Morningstar. “The fund employs various measures to address the liquidity risk. It allocates roughly 10 percent of its assets to cash and more-liquid high-yield bonds. The rest of the assets are skewed toward the most-liquid and largest loans. It also has a line of credit for emergency liquidity events.”