Fidelity Rolls Out First Open-End Bank Loan Fund

Fidelity Investments introduced its first bank-loan fund Wednesday in the form of Fidelity Advisor Floating Rate High Income Fund. Like its siblings, the portfolio will offer load share classes and will be sold only through brokers.

Bank-loan funds occupy an unusual niche in the investment world in that they hold loans rather than bonds and tend to focus on those made to companies with highly leveraged balance sheets. In exchange for the inherent credit risk, investors are compensated with high interest payments that typically float above a common short-term benchmark such as the London interbank offered rate, or LIBOR. Moreover, those interest payment levels are typically reset every 90 days or less, which helps stabilize loan prices even if interest rates shift around and allows investors to earn more income when interest rates rise.

Although Boston-based Fidelity isn't delivering a much-needed no-load option to the bank-loan fund universe, it is bringing to market the very first portfolio to be structured in the open-end mutual-fund format. Because bank loans don't trade as readily as stocks and bonds--they're illiquid, in industry parlance--other firms have structured their bank-loan funds as pure closed-end or continuously offered closed-end funds. Closed-end funds don't allow direct purchases or redemptions but can be bought and sold on public exchanges like stocks. The continuously offered variety, meanwhile, can take in new cash all the time, but they commonly permit redemptions, technically referred to as tenders, only quarterly. A notable exception is the unique no-load CypressTree Senior Floating Rate Fund (M)$-BBEE, which allows investors access to their money once a month.

Given the Fidelity fund's open-end structure, it will have to be careful about how it fills its portfolio. Too many hard-to-trade loans will mean the fund won't be able to easily raise cash to meet redemptions. Indeed, the fund's prospectus gives a nod to that issue and suggests that the fund may hold a large percentage of its assets in money-market securities, ostensibly to help provide ready cash, if redemptions pick up.

There's also reason to believe that the fund may prove a bit more selective in its bank-loan choices in an effort to bolster liquidity. The prospectus notes that Fidelity expects most of the fund's holdings to be part of loan deals that are at least $100 million in size. That effectively eliminates some of the smaller, more yield-rich deals that some competitors such as closed-end Pilgrim Prime Rate (PPR) have favored in the past.

The likelihood that the giant fund family's new offering will hold lots of cash and stick with bigger, more liquid loans suggests a slightly more conservative profile than those offered by its bank-loan competitors. Given Fidelity's deep analyst bench and lofty reputation for skillful credit analysis, however, this fund looks to have great potential.