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The Rise and Fall of Bank-Loan Funds

A Morningstar Category grapples with its future.

Bank-loan funds have had a difficult time. The Morningstar Category has endured outflows since late 2018, and following the March 2020 sell-off, it has shrunk to its smallest size since 2012. And the category's narrow return spread--a function of loans' ties to rock-bottom short-term interest rates and limited upside because of call risk--means that fees eat up a larger percentage of returns than in many other categories and make it difficult for individual funds to separate themselves from the pack.

Meanwhile, the bank-loan market itself has evolved in a direction that has undercut its traditional role as a credit-sensitive asset with more resilience than high-yield bonds. In fact, the bank-loan sector's traditional downside protection versus high-yield has been eroding for some time. More than ever before, bank-loan investors must ask themselves what they want out of their allocation and whether bank-loan funds are still able to deliver it.

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