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white paper 2010
the eVOLViNG MarKet FOr
FLOatiNG-rate LOaNS
While floating-rate loans (also referred to as senior secured loans, leveraged loans, bank loans or syndicated loans) have been around in
one form or another for more than 30 years, in the past decade the market has evolved from a traditional lending market to its current
position as a fully developed asset class within the capital markets. Given this evolution, we expect floating-rate loans to become
a more prevalent part of investors’ asset allocations moving forward, particularly given their diversification potential and the
measure of protection they may help provide in rising-interest-rate and higher-inflation environments. In this paper, we address
three major topics we expect will be of particular interest to clients researching the floating-rate loan market.
1 l aN iNtrOductiON tO FLOatiNG-rate LOaNS
Key characteristics of floating-rate loans (pages 4–7) �
The process of floating-rate loan issuance (pages 8–9) �
Types of companies issuing floating-rate loans today (page 9) �
2 l the eVOLutiON OF the
FLOatiNG-rate LOaN MarKet
A rise in popularity in the 1990s (page 10) �
Greater transparency for floating-rate loans (page 10) �
A brief history of the floating-rate loan market (page 11) �
3 l FLOatiNG-rate LOaNS withiN
aSSet aLLOcatiON
Diversification opportunities relative to traditional �
high-yield (pages 11–12)
Seeks a measure of protection from higher interest �
rates (page 13)
Seeks a measure of protection from higher inflation (page 14) �
Asset allocation does not assure or guarantee better performance and cannot
eliminate the risk of investment losses.
ExEcuTIvE SummAry
This report outlines the key characteristics, evolution and potential portfolio allocation benefits of floating-rate loans—an asset class which may be of interest to investors and their advisors in the current market environment.
cONtriButOrS
Ty Anderson, managing director, global head of high-yield strategies �
Eric meyer, managing director, head of uS loan portfolio management �
Jason vassil, vice president, fixed-income product specialist �
W h I T E pA p E r / / pA G E 2
Senior secured
Floating-rate loans are senior in a firm’s capital structure and �
secured by the issuing company’s assets, historically resulting
in attractive default and recovery rates (see page 7 for details).
diversification
Investment-grade bonds and floating-rate loans have offered a �
negative correlation to each other for the 15-year period ended
3/31/10 (see page 12 for details).
Given this negative correlation, adding a 30% floating-rate loan �
allocation to a hypothetical all-investment-grade bond portfolio
would have reduced overall portfolio risk as of 3/31/10 (see
page 12 for details).
potential protection from higher interest rates
Floating-rate loans offer a coupon that resets to higher interest �
rates, helping to mitigate interest-rate risk.
In fact, as interest rates move higher, this coupon reset may �
lead to potentially higher returns for floating-rate loans as
additional income payments boost returns and drive demand.
While past performance does not guarantee future results, �
in any 12-month period in which interest rates increased by
one percentage point or more, floating-rate loans substantially
outperformed intermediate-term, investment-grade bonds (see
page 13 for details).
potential protection from higher inflation
The total balance sheet of the Federal reserve hit an all time �
high of $2,174 billion, according to Deutsche Bank private
Wealth management as of 1/31/10. This influx of liquidity
could be cause for inflationary pressures. Generally, inflation is
associated with periods of higher interest rates and stronger
economic growth.
historically, during these periods, floating-rate loans have �
shown solid performance relative to intermediate-term,
investment-grade bonds (see page 14 for details).
This characteristic is supported by the high correlation between �
floating-rate loans returns and inflation, and the low correlation
of intermediate-term, investment-grade bonds and inflation
(see page 14 for details).
past performance is historical and does not guarantee
future results.
Solid performance
class S shares are ranked in the top 24% (33/134 funds) and
top 7% (7/100 funds) for the one-year and since-inception
periods (inception date of 6/28/07), respectively, as of 3/31/10
based on total returns in the morningstar Bank Loan category.1
Strong bear and bull market performance
The fund was the only fund within the morningstar Bank
Loan category that finished in the top 35% in the 2008 bear
market and top 24% in the 2009 bull market. (class S shares,
based on total returns, of 46/126 funds and 32/134 funds,
respectively (see page 16 for details).1
experienced and deep team
A team of seven individuals with more than 20 years of
experience on average is dedicated to the portfolio.
unique overlay strategy
The fund utilizes an additional proprietary overlay strategy,
which seeks to enhance returns with minimal impact on
volatility. This is supported by the high correlation between
floating-rate returns and inflation, and the low correlation of
intermediate-term, investment-grade bonds and inflation (see
page 14 for details).
SuMMarY OF FLOatiNG-rate LOaN KeY characteriSticS
dwS FLOatiNG rate pLuS FuNd hiGhLiGhtS
W h I T E pA p E r / / pA G E 3
Share class 1-month 3-month Ytd 1-year Life of fund inception date
Unadjusted for sales charges
A 2.40% 4.99% 4.99% 41.29% 3.11% 6/28/07
Adjusted for the maximum 2.75% sales charge
A –0.41% 2.10% 2.10% 37.40% 2.07% 6/28/07
No sales charges
S 2.42% 5.05% 5.05% 41.55% 3.29% 6/28/07
INST 2.31% 5.05% 5.05% 41.56% 3.29% 6/28/07
S&p/LSTA Leveraged Loan Index 2.25% 4.64% 4.64% 44.49% n/a n/a
class a S iNSt
Gross 1.62% 1.61% 1.45%
Net 1.20% 0.95% 0.95%
contractual through 9/30/10 9/30/10 9/30/10
Nasdaq symbols a c S iNSt
DWS Floating rate plus Fund DFrAx DFrcx DFrpx DFrTx
DWS FLOATING rATE pLuS FuND
Average annual total returns as of 3/31/10 (returns of less than one year are cumulative)
Performance is historical and does not guarantee future results. Investment return and principal fluctuate so your shares may be worth more or less when
redeemed. Current performance may differ from data shown. Please visit www.dws-investments.com for the fund's most recent month-end performance.
Unadjusted returns do not reflect sales charges and would be lower if they did. Fund performance includes reinvestment of all distributions. Not all share classes are
available to all investors.
The S&p/LSTA Leveraged Loan Index is an unmanaged, market-value-weighted total return index that tracks outstanding balance and current spread over the London Interbank
Offered rate (LIBOr) for fully funded loan terms.
ExpENSE rATIOS AS OF LATEST prOSpEcTuS
The net expense charge for this fund reflects a contractual fee waiver and reimbursement of various expenses by the fund’s advisor. Without this waiver/reimbursement,
returns and any ratings/rankings would have been lower.
riSK iNFOrMatiON
Loan investments are subject to interest-rate and credit risks. Floating rate loans tend to be rated below-investment grade and may be
more vulnerable to economic or business changes than issuers with investment-grade credit. Adjustable rate loans are more sensitive
to interest rate changes. As part of the global alpha strategy, the fund may use derivatives. Investing in derivatives entails special
risks relating to liquidity, leverage and credit that may reduce returns and/or increase volatility. In certain situations, it may be difficult
or impossible to sell an investment at an acceptable price. This fund is non-diversified and can take larger positions in fewer issues,
increasing its potential risk. See the prospectus for details.
W h I T E pA p E r / / pA G E 4
1 l AN INTrODucTION TO FLOATING-rATE LOANS
Floating-rate loans are variable-rate, senior-secured-debt
instruments issued by non-investment-grade companies.
Floating-rate loans have three characteristics which make them
unique as compared to most traditional fixed-income investments.
Each of these characteristics will be discussed in more detail
throughout the paper. Building on these key characteristics,
we will also explore how allocating a portion of a portfolio to
floating-rate loans can help add greater diversification and a
measure of protection from rising interest rates and higher
inflation. Of course, diversification neither assures a profit nor
guarantees against loss.
while historically banks made up the vast majority of lenders,
in the past decade institutional investors, such as mutual
funds, have become the most prevalent market lenders,
according to S&p/LSta.
FLOatiNG-rate LOaNS at a GLaNce
1. Floating-rate loans are issued with floating-rate coupons
that are tied to a variable rate index, most commonly,
the London Interbank Offered rate (LIBOr), and reset
every 30 to 90 days.2
2. Floating-rate loans are senior in a firm’s capital
structure, meaning investors receive principal and
income before equity or other debt holders.
3. Floating-rate loans are secured by the issuing
company’s assets, which can be transferred to the loan
holder in case of default.
BENEFITS OF FLOATING-rATE LOAN ISSuANcE
Benefits to the borrower
Lower borrowing cost relative to bond and equity issuance
An additional source of funding that would not be available
through bilateral loan agreements or individual lines of credit
Less expensive and more efficient to administer than bilateral
or individual credit lines
Benefits to the lender
contractual control
of company activities
most loan agreements require that a
company maintain a pre-determined
level of financial ratios (e.g., debt/
coverage) in order to avoid violating the
loan terms
Senior in capital
structure
Loan holders are first to be paid
income and principal, leading to greater
recovery rates in case of default
collateral Generally, loans are secured by assets
that can be transferred to the holder of
the loan in case of default, leading to
higher recovery rates
Diversification Because multiple parties are involved in
lending to a corporate entity, investors
avoid excessive single-name exposure
In the floating-rate loan structure, two or more parties agree to
make a loan to a borrower, with each lender having a separate
claim on the debtor, although there is a single loan contract.
Given that floating-rate loans are not publically registered
securities, they differ from traditional bonds in regard to who
can generally purchase loans. Direct purchases of floating-rate
loans are generally limited to institutions or accredited investors.
however, today non-accredited or non-institutional investors are
easily able to gain access to floating-rate loans through mutual
funds. Floating-rate loans have come to serve an important
purpose in today’s lending markets as they provide companies
with an alternative to funding operations through high-yield bond
issuance or bilateral commercial bank loans.
W h I T E pA p E r / / pA G E 5
KeY characteriSticS OF FLOatiNG-rate LOaNS
While floating-rate loans are debt of non-investment-grade companies, there are some key differences between floating-rate loans and
traditional non-investment-grade bonds, each of which this paper will discuss in detail.
chArAcTErISTIcS OF FLOATING-rATE LOANS AND hIGh-yIELD BONDS
characteristic uS loans uS high-yield bonds relative benefits
Fixed/floating rate Floating rate mostly fixed rateLoans offer floating-rate coupons, which potentially offer less
interest-rate risk
Seniority SeniorSenior or
subordinated
Loans are the most senior debt in the capital structure of non-
investment-grade companies
Security Secured unsecuredLoans are generally secured by company assets, potentially
leading to higher recovery rates
Term at issuance 6 to 9 years 7 to 10 years Loans are generally slightly shorter-term
Liquidity Lower higher however, loans generally are less liquid than high-yield bonds
Floating-rate coupon
One key characteristic of floating-rate loans is that their
coupons float and are tied to a variable interest rate such
as LIBOR. Therefore, a floating-rate loan will be issued with a
coupon that pays a predetermined excess rate above that variable
interest rate. This excess rate or “spread” will be determined by
several factors, including the credit quality of the loan at issuance,
maturity of the loan and collateral, as well as other factors.3
Generally speaking, the higher risk of the loans (i.e., their lower
credit quality), the higher the spread associated with the loan.
historically, average yields on loans have ranged anywhere from
5.5% to 14.5% depending on credit quality of the loan, according
to S&p/LSTA.
As the example at right highlights, when a loan coupon’s variable
rate increases, the loan’s interest payment increases accordingly.
Loan coupons generally reset to the new variable rate every 30 to
90 days depending on the issue. This floating-rate component of
loans helps to mitigate interest-rate, or duration, risk.4
unlike a fixed-rate instrument, whose price will increase or
decrease inversely to the interest-rate move, the price of floating-
rate loans would not be expected to increase or decrease
due to interest-rate moves; however, the higher interest rates
should provide investors with higher income payments as the
loan coupon payments reset. A point to note: While interest
payments are not expected to impact loan pricing, other factors,
such as negative credit events, changes in loan supply and
demand, would potentially impact loan prices.
issuance
Loan spread LIBOr + 250 basis points (bps)
LIBOr rate 50 bps
Loan coupon 300 bps (50 bps + 250 bps)
LIBOR moves from 50 bps to 100 bps
Loan spread LIBOr + 250 bps
New LIBOr rate 100 bps
New loan coupon 350 bps (100 bps + 250 bps)
Source: S&p/LSTA. A basis point (bps) is one hundredth of a percentage point.
W h I T E pA p E r / / pA G E 6
Seniority
Another attractive characteristic of floating-rate loans is that
they are senior in the capital structure of non-investment-
grade companies. What this means to investors is that a loan’s
interest and principal is paid before that of any other equity or debt
holders in a firm’s capital structure. As a result, the risk of losses
on loans relative to traditional non-investment-grade bonds is
reduced. For a typical firm, loans comprise about 45% to 50% of
the firm’s capital structure, meaning loans benefit from a cushion
from subordinated debt and equity commitments.
Therefore, as income and principal are repaid, loan investors are
paid first. If a company defaults, then equity and bond holders
take losses first. In short, income and principal repayments flow
from the top down (from floating-rate loan investors to equity
investors) and losses flow from the bottom up (from equity
investors to floating-rate loan investors). As a result, floating-rate
loan investors carry lower risk than other investors in the capital
structure.
Secured by assets
In the floating-rate loan market, collateral usually includes
tangible and intangible assets of the borrower, including assets
such as property, equipment, intellectual property, accounts
receivables and inventories, among others. In the case of default,
these assets can be sold and proceeds dispensed to the loan
investor. This aspect of loans is highly attractive because it helps
to mitigate downside risks associated with the investment.
It is also important to note that in some cases loans may be
over-collateralized. This simply means there are generally more
assets or collateral than the outstanding value of the loan. While
this aspect of floating-rate loans does not immunize investors
from potential losses, it does help to minimize potential losses, as
highlighted by floating-rate loans’ higher recovery rates, which will
be discussed in more detail later in this paper. In addition, this may
help provide investors with a measure protection from potential
deterioration of asset or collateral value.
A TypOLOGy OF FLOATING-rATE LOANS
Source: Deutsche Asset management
Second-lien loans Mezzanine loans
High-yield bonds
Equity
Floating-rate loans
Characteristics and benefits of floating-rate loans
Junior secured capital
Unsecured capital(Second loss capital)
First losscapital
Characteristic —Most senior debt obligation in capital structure
Secured by assets
Benefit —Interest and principal paid before equity and debt holders
A measure of downside protection in case of default
Sen
iorit
y
Floating-rate loans
Senior unsecured bonds
Senior subordinated bonds
Subordinated bonds
Equity
Floating-rate loans(Senior secured loans)
(Generally 45%-50% of firm’s capital structure)
W h I T E pA p E r / / pA G E 7
The senior secured aspect of floating-rate loans is an
important characteristic to shareholders as highlighted by
historical default and recovery rates. As a way of explanation,
a default occurs when a borrower does not make interest or
principal payments as agreed upon. A recovery rate is the
percentage of the outstanding loan or debt value which is
recovered by an investor in the case of default. For example, if a
company defaults and an investor realizes a 100% recovery rate,
then the entire value of outstanding loan was recovered by an
investor. On the other hand, if the recovery rate is 50%, then an
investor only recouped 50% of the initial investment.
From 2001 to 2009, floating-rate loans have experienced
about half of the default rate of traditional non-investment-
grade bonds. From 1987 to 2009, they provided a recovery
rate of more than 81% on average. compare this latter figure
to traditional subordinated debt, which has an average recovery
rate of 31%. In short, this means that given the senior secured
aspect of floating-rate loans, even in the case of default, investors
recouped 81% of what was owed to them, while a subordinated
debt investor recouped only 31%. This lower default rate and
higher recovery rate highlight the potential protection floating-
rate loans may offer investors relative to traditional unsecured or
subordinated debt.
what these characteristics mean to investors: Floating-rate loans offered attractive default and recovery rates
ATTrAcTIvE DEFAuLT rATES AND rEcOvEry rATES
Source: moody’s Investor Services as of 12/31/09. Past performance is historical and does not guarantee future results. Default rate is for the trailing 12-month period.
Default rates for 2001, 2002, 2003 and 2004 are by number of issuers. Subsequent to 2004, the default rate is dollar-weighted. Default rate is for the trailing 12-month period.
Default is defined as missed interest or principal disbursement, bankruptcy, distressed exchange or an ongoing covenant violation. Average recovery rates over other time
periods might not be as favorable.
High-yield
Average default rate from 2001 – 2009 Average recovery rate from 1987 – 2009
Floating-rate loans Senior unsecuredFloating-rate loans Subordinated debt
0%
1%
2%
3%
4%
5%
6%
7%
8%
9%
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
3.63% 7.12% 81.10 % 44.60% 31.00%
W h I T E pA p E r / / pA G E 8
the prOceSS OF FLOatiNG-rate LOaN iSSuaNce
For those who are somewhat unfamiliar with floating-rate loans,
loan structuring and issuance may seem complex, but in reality it
is relatively straightforward.
Floating-rate loan issuance begins when a company (or issuer)
decides to raise capital through the loan market instead of the
debt or equity markets. This firm will reach out to a commercial
or investment bank (known as an arranger) to facilitate the loan
issuance. An arranger serves the role of raising investor dollars
for a firm that is need of capital. Before awarding a mandate, the
issuer might solicit bids from a variety of arrangers.
Once the mandate is awarded, the syndication process starts. The
arranger will prepare an information memo describing the terms
of the transactions. The information memo typically will include
a variety of information, including the issuing firm’s financial
statements, terms and conditions of the loan and collateral, etc.
Loans are not securities, so the offering is usually confidential
and made only to qualified and accredited investors. (however,
as previously mentioned, today non-qualified investors have the
ability to invest in loans through mutual funds.) As the information
memo is prepared, the arranger solicits informal feedback from
potential investors about interest in the deal and potential pricing.
FLOATING-rATE LOAN ISSuANcE prOcESS
While the above description highlights loan issuance on the primary market, a highly active secondary market for loans also �
exists. Secondary sales occur after the loan has closed and been allocated and investors are free to trade the loan. Investors
usually trade through dealer desks and can sell or buy loans in one of two ways: assignment or participation.
In the assignment arrangement, the new owner of the loan (assignee) becomes a direct signatory of the loan and receives �
interest and principal payments directly from the issuer of the loan (through the administrative agent). Assignment typically
requires consent of both the borrower and agent. In short, the purchaser of the loan becomes its legal owner.
In the participation arrangement, the original investor remains the legal owner of the loan but agrees to allow another investor to �
share in a portion of the loan for a fee. Therefore, the new purchaser receives interest payments on a portion of the loan but is
not a legal owner of the loan.
the SecONdarY MarKet FOr FLOatiNG-rate LOaNS
After this information has been gathered, the arranger will formally
market the deal to potential investors. Once investors in the
loan are finalized and the loan is closed, the final terms are then
documented in detailed credit and security agreements. During
the process an administrative agent, which is generally a bank, is
chosen to handle and transmit all interest and principal payments
to investors in the loan. Following issuance, loan terms can be
revised and amended from time to time, but amendments require
approval from the investors.
Issuing company— Company which borrows money
through syndication process. Loan becomes a direct
debt obligation within firm’s capital structure.
Lead arranger or bookrunner— Bank hired by
borrowing company to stucture syndicate, promote
and sell the loans to investors.
Administrative agent— Bank which handles and
transmits all interest and principal payments to
investors and monitors the loan.
Loan investors (Participants)— Investors providing
the funds to the issuing company by purchasing
the loan. Consists of more than one investor.
Loan
is a
dire
ct d
ebt
oblig
atio
n of
the
issu
ing
com
pany
W h I T E pA p E r / / pA G E 9
a GrOwiNG MarKet FOr FLOatiNG-rate LOaNS
The floating-rate loan market has grown more quickly in recent years relative to the non-investment-grade (high-yield) bond market.
As of 12/31/09, the floating-rate loan market had $531 billion in outstanding loans—almost two thirds the high-yield market.
tYpeS OF cOMpaNieS iSSuiNG FLOatiNG-rate LOaNS
Today a broad and diverse universe of companies, across multiple sectors, issue floating-rate loans. The S&p/LSTA Syndicated Loan Index
contains more than 1,000 loans across nearly 40 industries from about 600 issuers, such as Georgia-pacific corp., Goodyear Tire & rubber
co. (0.3%), Delta Airlines (0.7%), Ford motor co. (0.8%) and Wrigley co. (0%) to name a few.5
Source: Standard & poors and morningstar as of 12/31/09
FLOATING-rATE LOANS ISSuED By cOmpANIES FrOm vArIOuS SEcTOrS
Source: S&p/LSTA, as of 12/31/09
0
100
200
300
400
500
600
700
800
900
1000
1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
$ bi
llion
s
35
209
73 101
247
117 130 132 148
274338 373
496562
193248
588643
400
675
557
709
596
782
531
887
High-yield bonds outstandingFloating-rate loans
Utilities
Telcommunications
Retailers
Publishing
Oil and gas
Leisure
Hotels/motels/inns and casinos
Health care
Food products
Financial intermediaries
Electronics/electric
Chemical/plastics
Cable television
Business equipment and services
Building and development
Broadcast radio and television
Automotive
Other
0% 5% 10% 15% 20%
7.09%
3.74%
3.99%
7.66%
2.91%
3.33%
4.59%
9.43%
1.98%
4.59%
3.22%
5.78%
4.45%
5.72%
3.60%
4.59%
5.00%
18.31%
GrOWTh OF FLOATING-rATE LOAN mArKET vS. hIGh-yIELD BOND mArKET
W h I T E pA p E r / / pA G E 1 0
These two aspects of floating-rate loans caused most investors to
view loan mutual funds as more conservative “cash alternatives.”
Because of the lack of ratings, some investors were not aware
that these were non-investment-grade securities, and given the
fair value pricing of loans, price movement on loans or the funds
that invested in them was minimal. In short, floating-rate loan
portfolios had very little pricing and investment transparency.
Greater traNSpareNcY FOr
FLOatiNG-rate LOaNS
however, the environment for floating-rate loans changed
dramatically between 2000 to 2002 as the pending recession
and regulatory changes left some floating-rate loan fund
investors surprised.
In 2000, the Securities and Exchange Commission (SEC)
mandated that floating-rate loan managers begin pricing
securities at mark-to-market levels. The new pricing
transparency associated with the mark-to-market rules led to
floating-rate loan funds to experience negative returns for the first
time (first category monthly loss in march of 2001 following more
than 12 years of consecutive monthly gains).
The credit crises of 2007 to 2008 were also important for the
floating-rate loan market. A deteriorating economy, increasing
default rates and a vicious cycle of financial deleveraging drove
loan prices to historic lows. This was the first calendar year loss
for the floating rate fund category since its inception in 1988.
While the market downturn was driven in a large part by technical
factors such as a lack of liquidity and supply/demand factors, the
subsequent rebound quickly brought back loan valuations, making
up most of the 2009 losses.
Like any investment with credit risk, the economic environment
that is advantageous for potentially increasing or reducing
exposure is a key factor to success. When used correctly,
floating-rate loans can offer attractive opportunities, which we
will now discuss.
STAGES OF FLOATING-rATE LOAN mArKET
DEvELOpmENT
The floating-rate loan market has grown rapidly in recent years,
with total loans outstanding having grown from $35 billion in 1997
to more than $530 billion as of 12/31/09 (source: S&p/LSTA).
three stages of floating-rate loan history
1970s and
early 1980s
The primary market for floating-rate loans
was dominated by government borrowers
of emerging economies.
mid- to-late 1980s This period of development was driven by
the boom in mergers and acquisitions and
leveraged buyout activity.
1990s to today General corporate funding has become
the dominant part of the floating-rate loan
market.
2 l ThE EvOLuTION OF ThE FLOATING-rATE LOAN mArKET
a riSe iN pOpuLaritY iN the 1990s
Over its evolution the loan market has become much more
transparent and information is increasingly available. Two key
unsustainable factors led to floating-rate loan fund success
and popularity in the early and mid 1990s.
First, floating-rate loans generally were not rated by any credit
rating agencies until the mid-1990s, and then, until more recent
years, only on a limited basis (in 1996 Standard & poor’s began
rating corporate floating-rate loans, according to the milken
Institute, 2004).
Second, the secondary market for loans was limited, as floating-
rate loans were valued within floating-rate loan funds at fair value
and not market value.6 In January 1996, The Loan Syndications
and Trading Association (LSTA), began providing monthly mark-to-
market pricing based upon dealer quotes.7 In late 1999, the LSTA
licensed Loan pricing corp. to run the mark-to-market service,
which resulted in an overnight four-fold growth in the number of
loans priced daily.
W h I T E pA p E r / / pA G E 1 1
A BrIEF hISTOry OF FLOATING-rATE LOANS (mOrNINGSTAr BANK LOAN cATEGOry mONThLy
rETurNS, 1989-2010)
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999
morningstar Bank Loan category returns 9.60% 8.03% 6.21% 5.70% 6.60% 7.80% 6.75% 7.31% 6.28% 6.23%
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
morningstar Bank Loan category returns 6.23% 2.30% 0.84% 10.11% 5.02% 4.58% 6.61% 1.08% –30.22% 41.44%
Source: morningstar and DWS Investments as of 3/31/10. Source for default rates is moody’s Investor Services. Past performance is historical and does not guarantee
future results. Data is for illustrative purposes and does not represent any DWS fund. category returns do not reflect fees or expenses. It is not possible to invest directly in
an category. performance over other time periods might not be as favorable.
3 l FLOATING-rATE LOANS WIThIN ASSET ALLOcATION
Institutional clients have long recognized the benefits of investing
in floating-rate loans. however, in the past decade more retail
investors have also begun to recognize how allocating to floating-
rate loans can potentially benefit a portfolio. In this next section,
we explain the three unique benefits of floating-rate loans. Asset
allocation does not assure or guarantee better performance and
cannot eliminate the risk of investment losses.
diVerSiFicatiON BeNeFitS reLatiVe tO
traditiONaL hiGh YieLd
Investors have historically limited fixed-income allocations to only
two markets: investment-grade and sub-investment-grade bonds.
however, institutional investors have long recognized the benefits
of another unique fixed-income asset class in floating-rate loans.
This asset class is considered by many to be a hybrid market with
a risk/return profile that falls between that of investment-grade
and non-investment-grade bonds.
–15
–10
–5
0
5
10
3/109/099/089/079/069/059/049/039/029/019/009/999/989/979/969/959/949/939/929/919/909/89
Ret
urn
Time period
2008 Liquidity/credit
crunch drives prices to all-time lows
March 2001 Bank loan
category has first monthly loss
1989Van Kampen and
Eaton Vance funds launch8
2009 Great credit recovery: Prices
rise even as defaults hit record high of 10.87%
2002Recession
drives default rates to 7.41%
2000SEC mandates mutual funds mark loans to
market value
1988Pilgrim Fund
launches
hOw addiNG FLOatiNG-rate LOaNS caN
aid pOrtFOLiO aSSet aLLOcatiON
diversification: The risk/return characteristics of floating-
rate loans are unique in that they fall between traditional
investment-grade debt and sub-investment-grade debt,
making them a key diversification tool. Diversification
neither assures a profit nor guarantees against loss.
potential protection from higher interest rates:
Floating-rate loans offer floating-rate coupons, which
can help mitigate interest-rate, or duration, risk.
potential protection from higher inflation: Floating-rate
loans have historically offered a measure of protection
from higher inflation because the environments in
which they tend to outperform are generally the same
environments that lead to higher inflation.
W h I T E pA p E r / / pA G E 1 2
Floating-rate loans and investment-grade bonds carry different
risks, and when used in combination, they may offer an
opportunity for an attractive return stream that can potentially
benefit investors during multiple market cycles. The chart below
highlights differences in key risk characteristics.
Given that investment-grade bonds carry less credit and liquidity
risk but more interest-rate risk, they will generally outperform
during periods of weakening economic conditions, which are
associated with higher default rates and lower interest rates.
however, the opposite holds true for floating-rate loans, which
contain a higher level of credit and liquidity risk but with minimal
interest-rate risk. Therefore, floating-rate loans generally
outperform during periods of improving economic conditions,
which are associated with lower default rates higher interest
rates. Of course, past performance does not guarantee
future results.
The differences between floating-rate loans and investment-grade
bonds are what led to the attractive risk/return characteristics.
The diversification benefits of combining both floating-rate loans
and investment-grade bonds are highlighted by the fact that the
correlation between floating-rate loans and investment-grade
bonds is –0.02% for the 15-year period ended 3/31/10, according
to morningstar, Inc.9
DIFFErENcES IN KEy rISK chArAcTErISTIcS
interest-rate risk credit risk Liquidity risk income potential potentially optimal environment
Floating-rate loans Low medium medium mediumStrengthening economy/ rising rates
Investment-grade bonds Low to high Low Low LowWeak economy/ falling rates
Non-investment-grade bonds
medium high medium highStrengthening economy/flat rates
In turn, the low correlation and diversification benefits have the potential to create a combined portfolio that offers attractive return and
yield with lower overall volatility than a 100% investment-grade portfolio (as shown in chart below).
pOTENTIAL TO hELp prOTEcT AND ENhANcE A hypOThETIcAL FIxED-INcOmE pOrTFOLIO
Source: DWS Investments as of 3/31/10. Past performance is historical and does not guarantee future results. Asset class representation: floating-rate loans, credit Suisse
Leveraged Loan Index, which is designed to mirror the uS leveraged loan market; investment-grade bonds, Barclays capital uS Aggregate Index, which represents domestic
taxable investment-grade bonds with average maturities of one year or more. Data is for illustrative purposes and does not represent any DWS fund. Index returns do not reflect
fees or expenses. It is not possible to invest directly in an index. performance over other time periods might not be as favorable. risk is measured by standard deviation.
Source: Deutsche Asset management.
2.5% 3.0% 3.5% 4.0% 4.5% 5.0% 5.5% 6.0%
5.9%
6.0%
6.1%
6.2%
6.3%
6.4%
6.5%
6.6%
Ret
urn
Risk
100% investments-grade bonds
70% investment-grade bonds / 30% floating-rate loans
Investment-grade vs. senior secured loans (Feb.1992–March 2010)
W h I T E pA p E r / / pA G E 1 3
One of the most attractive features of floating-rate loans is the
potential measure of protection they may provide from higher
interest rates. There are two main reasons behind floating-rate
loan performance during a higher-interest-rate environment.
First, the floating coupon associated with floating-rate loans.
Given that floating-rate loans reset their coupons payments every
30 to 90 days, they have minimal interest-rate, or duration, risk.4
Therefore, unlike fixed-rate instruments, which will experience
a decline in price as interest rates increase, floating-rate loans
will generally benefit from higher interest rates through higher
coupon and income payments with minimal impact to the price
of the loans. In short, the returns of floating-rate loans would be
expected to be higher during periods of rising interest rates given
the additional income that is being earned, while the returns of
traditional fixed-rate bonds would expected to be lower during
these periods.
The second component of loans that may potentially lead to
outperformance during rising-rate environments is that floating-
rate loans are impacted more significantly by deterioration of
general credit market or economic conditions. In general, their
returns are impacted positively during periods of improving
economic and credit conditions, which are also generally
associated with higher interest-rate cycles. The opposite is true
during economic downturns.
The chart below highlights the returns of floating-rate loans, short-
term bonds and intermediate-term bonds during periods in which
interest rates rose by one percentage point or more since 1992.
As would be expected, intermediate-term bonds with a high level
of interest-rate risk experienced the lowest returns (–0.08%) with
the highest volatility (3.68%). On the other hand, floating-rate
loans experienced significantly higher returns (10.27%) with less
risk (1.40%) over the same periods.
The risk higher interest rates may have on an investor’s fixed-
income allocation is important and that is many times overlooked
during portfolio construction. An allocation to floating-rate loans is
a compelling option to help investors seek a potential measure of
protection from higher interest rates.
pOteNtiaL prOtectiON FrOM hiGher iNtereSt rateS
pOTENTIAL BENEFIT OF FLOATING-rATE LOANS DurING rISING-rATE ENvIrONmENTS
Source: morningstar Inc., as of 12/31/09. Past performance is historical and does not guarantee future results. Asset class representation: Floating-rate loans, credit Suisse
Leveraged Loan Index; intermediate-term bonds, Barclays capital 5-7 year uS Aggregate Index, which with average maturities of five to seven years; short-term bonds, Barclays
capital 1-3 year uS Aggregate Index, which represents domestic taxable investment-grade bonds with average maturities of one to three years. Data is for illustrative purposes
and does not represent any DWS fund. Index returns do not reflect fees or expenses. It is not possible to invest directly in an index. performance over other time periods might
not be as favorable. volatility is measured by standard deviation. performance over other time periods might not be as favorable.
time period 10/93 — 10/94 1/99 — 1/00 5/03 — 5/04 6/05 — 6/06
One-year rise in interest rates 2.38% 2.02% 1.29% 1.21%
Floating-rate loan returns 13.35% 5.43% 8.30% 6.66%
Short-term bond returns 1.33% 2.85% 1.10% 1.96%
Intermediate-term bond returns –2.28% –0.91% –1.52% –0.37%
Average annual return
Short-term bondsFloating-rate loans Intermediate-term bonds
0%
4%
8%
12%
10.27% 2.27% –0.08%
Average volatility
Short-term bondsFloating-rate loans Intermediate-term bonds
0%
1%
2%
3%
4%
2.46% 1.40% 3.68%
W h I T E pA p E r / / pA G E 1 4
pOteNtiaL prOtectiON FrOM hiGher iNFLatiON
Another attractive feature of floating-rate loans is the potential
measure of protection that they may offer from higher inflation.
While floating-rate loans do not have a specific imbedded
inflation hedge, their floating coupons may offer a measure
of protection from inflation. There are several reasons this is
the case, which we will discuss in more detail. First, inflationary
pressures tend to rise during periods of economic expansion,
which are also associated with higher interest rates.
As discussed in the previous section, a period of economic
expansion and higher interest rates tends to lead to
outperformance of floating-rate loans.
Given that inflation tends to move higher in these periods, loan
returns historically have increased during the same periods
in which inflation pressure take hold, as highlighted by their
high correlation to inflation in the chart below.
So while floating-rate loans may not have a direct inflation hedge
imbedded in their structure, there is potentially a measure of
protection from higher inflation because the environments in
which floating-rate loans tend to outperform are generally the
same environments that lead to higher inflation.
FLOATING-rATE LOANS OFFErED pOSITIvE cOrrELATION TO INFLATION (FIvE-yEAr pErIOD ENDED 3/31/10)
Source: morningstar, as of 3/31/10. Past performance is historical and does not guarantee future results. Asset class representation: inflation, uS Bureau of Labor Statistics,
cpI All urban; floating-rate loans, morningstar Bank Loan category; commodities, morningstar Natural resources category; short-term bonds, morningstar Short-Term Bond
category; large-cap equities, morningstar Large Blend category; uS TIpS, morningstar Inflation protected Bond category; intermediate-term bonds, morningstar Intermediate-Term
Bond category. This data is for illustrative purposes and does not represent any DWS fund. It is not possible to invest directly in a category. correlation refers to how securities
or asset classes perform in relation to each another and/or the market. A 1.0 correlation indicates that two security types move in exactly the same direction. A –1.0 correlation
indicates movement in exactly opposite directions. A zero correlation implies no relation in the movements. correlation over other time periods might not be as favorable.
Inflation
Floating-rate loans
Commodities
Short-term bonds
Large-cap equities
US TIPS
Intermediate-term bonds
–0.10 0.01 0.12 0.23 0.34 0.45 0.56 0.67 0.78 0.89 1.00
1.00
0.47
0.27
0.12
0.11
0.11
–0.08
W h I T E pA p E r / / pA G E 1 5
cONcLuSION
Our research finds that floating-rate loans have the potential to provide several potential benefits when added to a fixed-income portfolio’s allocation.
1 l DIvErSIFIcATION OppOrTuNITy
First, floating-rate loans may potentially offer attractive diversification opportunities when added to a traditional investment-grade bond
portfolio. This is highlighted by the low correlation between the two investments. This low correlation may lead to lower volatility of a
combined floating-rate loan/investment-grade bond portfolio relative to an investment-grade-only portfolio (see pages 11–12 for details).
2 l pOTENTIAL INTErEST-rATE rISK hEDGE
Second, floating-rate loans present investors with a tool to help hedge the interest-rate risk that threatens traditional bond asset
classes. While past performance is historical and does not guarantee future results, during any period from 1992 to 2009 when interest
rates increased by one percentage point or more, floating-rate loans provided the highest return compared to short-term bonds and
intermediate-term bonds (see pages 13 for details).
3 l pOTENTIAL INFLATION rISK hEDGE
Third, floating-rate loans present investors with a tool to help hedge inflation risks that threaten a traditional bond assets classes. This is
highlighted through the high correlation between inflation and floating-rate loan returns (see page 14 for details).
as discussed in the paper, the floating-rate loan market experienced numerous transformations since its inception. it has grown
to become a fully developed asset class in size, scope and liquidity and now attracts multiple investor types. Given the growth
of today’s floating-rate loan market and the opportunities floating-rate loans may provide investors, we believe floating-rate
loans will become a more prevalent part of retail investors’ asset allocations moving forward.
© 2010 DWS Investments Distributors, Inc. All rights reserved. pm102742 (05/10) r-16953-1 FLOATING-WhITE
DWS Investments Distributors, Inc.222 South riverside plaza chicago, IL 60606-5808www.dws-investments.com [email protected] (800) 621-1148
NOT FDIC/NCUA INSURED MAY LOSE VALUE
NO BANK GUARANTEE NOT A DEPOSIT
NOT INSURED BY ANY FEDERAL GOVERNMENT AGENCY
DWS Investments is part of Deutsche Bank’s Asset management division and, within the uS, represents the retail asset management activities of Deutsche Bank AG, Deutsche Bank Trust company Americas, Deutsche Investment management Americas Inc. and DWS Trust company.
OBTAIN A PROSPECTUS To obtain a summary prospectus, if available, or prospectus, download one from www.dws-investments.com, talk to your financial representative or call (800) 621-1048. We advise you to carefully consider the product’s objectives, risks, charges and expenses before investing. The summary prospectus and prospectus contain this and other important information about the investment product. Please read the prospectus carefully before you invest.
NOteS1 Source: morningstar, Inc., as of 3/31/10. rankings and ratings are historical and do not guarantee future results. class S shares of DWS Floating rate plus Fund were ranked
as follows in the morningstar Bank Loan category: one-year, 33/134 funds; three-year, not available; five year, not available; 10-year, not available; since inception on 6/28/07,
7/100 funds. rankings are based on a fund’s total return with distributions reinvested. rankings of other share classes may vary. 2 LIBOr (London Interbank Offered rate) is an interest rate at which banks can borrow funds, in marketable size, from other banks in the London interbank market.3 credit quality is a measure of a bond issuer’s ability to repay interest and principal in a timely manner. rating agencies assign letter designations such as AAA, AA and so
forth. The lower the rating, the higher the probability of default. 4 Duration is a measure of the sensitivity of the price of a fixed-income investment to a change in interest rates.5 percentages in parentheses represent percentages of the fund’s market value as of 3/31/10. Securities referenced do not represent all of the securities purchased or sold by
the fund, may or may not be profitable, and should not be construed as a recommendation of any specific security. current and future portfolio holdings are subject to risk. 6 Fair value is the estimated value of all assets and liabilities of an acquired company used to consolidate the financial statements of both companies.7 mark to market is a measure of the fair value of accounts that can change over time, such as assets and liabilities. mark to market aims to provide a realistic appraisal of an
institution's or company's current financial situation.8 Eaton vance Floating rate Advantage Fund: www.eatonvance.com, Two International place, Boston, mA 02110. van Kampen Senior Loan Fund: www.vankampen.com,
1 parkview plaza, Suite 100, p.O. Box 5555, Oakbrook Terrace, IL 60181.9 correlation refers to how securities or asset classes perform in relation to each another and/or the market. A 1.0 correlation indicates that two security types move in exactly
the same direction. A –1.0 correlation indicates movement in exactly opposite directions. A zero correlation implies no relation in the movements.
Past performance is no guarantee of future results. The opinions and forecasts expressed herein by the fund managers do not necessarily reflect those of DWS
Investments, are as of 3/31/10 and may not come to pass.