The Federal Reserve has kept short-term interest rates at historically low levels for several years. Although the Fed doesn’t actually control interest rates, its federal funds rate target anchors rates at the short end of the interest-rate curve. The federal funds rate is the rate at which banks can borrow money overnight from commercial banks.

Putting aside the economic impact of the currently low-rate environment, the current level of rates is historically low. Unless the United States has entered into an entirely new paradigm, it is highly likely that rates will revert to a more normal, and higher, level at some point in the future. It is, of course, impossible to tell when rates will rise or by how much, which makes investing for income a complicated process without many good answers.

One potential, though hardly perfect, option is a floating rate fund. These funds generally invest in what are known as bank loans. Such loans generally carry interest rates that fluctuate based on changes in the broader interest-rate environment. The interest rates on these loans are generally tied to a broad interest rate index, such as The London Interbank Offered Rate (LIBOR).

Clearly, a changing rate structure is a double-edged sword. When interest rates are going down, the interest these loans pay decreases, which is good for the borrower, but not so for the lender. As rates are increasing, the interest these loans pay goes up, which is good for the lender but not so good for the borrower. With interest rates near historic lows, benefits seem more likely to accrue to lenders over the long term.

Rate changes, however, aren’t the only risks associated with these securities. Bank loans are generally of short duration and are often backed by collateral. Moreover, they are generally senior to other forms of debt and equity in the case of a bankruptcy. Therein, though, lies the risk. The companies that get bank loans are often smaller and riskier in nature. Some recipients are in the middle of restructurings, leveraged buyouts, or even emerging from bankruptcy.

Additionally, collateral is only worth what someone will pay for it when it is sold—which may be for less than what was lent. Moreover, being high up on the creditor list is shallow solace for owning the debt of a bankrupt company and all of the complications that entails. So, clearly, mutual funds that specialize in bank loans are not for the risk averse.

Still, owning such securities through a fund is clearly a preferable option to owning individual securities. The mutual fund benefits of specialized management, instant diversification, and ease of the purchase and sale of shares (of the mutual fund) make the risks of the bank loan market far more palatable for investors small and large.

The real benefit here, however, is that, if rates go up, the bank loans that floating rate loan funds own will start to move higher, as well. Thus, the distribution from such securities will eventually move higher as well (there is a lag between rate changes and when interest rates on these securities reset). This should both provide a larger income stream and protect the principle value of the securities over time as compared to other income offerings. Clearly, owning such securities in a diversified portfolio could be beneficial for those willing to take on the added risk.

Some interesting options in this space include:

Fidelity Floating Rate High Income Fund (FFRHX)
Manager: Christine McConnell
Overall Rank: 3 (Average)
Risk Rank: 4 (Above Average Risk)

MainStay Floating Rate Fund A (MXFAX)
Manager: Robert Dial
Overall Rank: 4 (Below Average)
Risk Rank: 4 (Above Average Risk)

Eaton Vance Floating Rate Fund A (EVBLX)
Manager: Team Managed
Overall Rank: 4 (Below Average)
Risk Rank: 4 (Above Average Risk)

Invesco Floating Rate Fund A (AFRAX)
Manager: Tom Ewald and Greg Stoeckle
Overall Rank: 5 (Lowest)
Risk Rank: 4 (Above Average Risk)

At the time of this article's writing, the author did not have positions in any of the companies mentioned.