The decision by the Federal Reserve to cut interest rates by one-half of a percent to 1.25% may have been greeted by the wider market as a welcome boost, but it is another kick in the face to the long-suffering prime-rate funds. The net asset value of the funds has fallen from a peak of $30.6 billion in 1999 to $17 billion as of September, and the prime-rate funds now only contribute 10-20% of total fund flows to the high-yield loan market, according to data fromBanc of America Securities. Furthermore, the effects of the current environment are starting to take a more drastic toll.
As reported on Loan Market Week's Web site last week, Scudder Investments is liquidating its bank loan fund and will be returning the value of the fund to investors by Dec. 20. In a letter to its shareholders, the retail fund manager attributed the liquidation to weak credit conditions and low interest rates. "Even though Scudder believes market conditions will eventually improve, we believe that investor sentiment toward the bank loan market and bank loan funds will not easily change, limiting future growth opportunities for Scudder Floating Rate Fund," the letter stated. Kenneth Weber, a portfolio manager for the Scudder fund, declined to comment on the situation. The lead portfolio manager for the fund, Kelly Babson, could not be reached for comment.
Scudder had been trying to reposition the fund over the past year to reflect the tougher conditions in the market. Exposure to cable and telecommunications companies was a drag to the fund's performance, therefore management increased the fund's exposure to non-cyclical areas such as aerospace, defense, food products and healthcare, which helped returns, according to the fund's annual statement. Although it could not be ascertained how much of the fund has been sold already or at what values, a list of the funds holdings' at mid-year is available at www.scudder.com.
Although the picture for prime-rate funds appears dire, one veteran fund manager thinks differently. Prime-rate funds are shrinking, similar to 1991 when LIBOR shrunk, he noted. But once LIBOR rose, the funds came back stronger, he said.