Why You Shouldn’t Rule Out Bank Loans

After an extended period during which floating-rate loans rewarded investors with generous income and low volatility, sentiment has swung sharply the other way.

Fundholders have headed for the exits, unnerved first by expectations of additional Federal Reserve rate cuts and then by pockets of acute industry‑specific stress, most notably the recent software selloff. US bank‑loan mutual funds and exchange-traded funds shed more than $11 billion over the trailing year through April 2026, making it one of only two fixed‑income Morningstar Categories to suffer net outflows during a period when the broader US taxable‑bond fund group welcomed nearly $713 billion in new money. And that’s not counting the $9.3 billion that left bank-loan funds in April 2025, the category’s third-largest net monthly outflow on record.

Much of the recent volatility stems from the software industry, which represents roughly 12% of the Morningstar LSTA US Leveraged Loan Index and is more than twice the size of the next‑largest industry. Its prominence has become a vulnerability. Artificial intelligence‑driven displacement fears and a reevaluation of leveraged software business models caused spreads on software loans to jump from 479 to 718 basis points between Jan. 9 and Feb. 27, 2026, a 51% increase compared with just a 14% move for the broader loan market. Performance followed suit: While the overall index slipped 1.38%, software loans fell 7.25% over the same span.

Some of this reflects the hangover from the industry’s rapid expansion. Between 2020 and 2025, outstanding software‑issuer loan balances ballooned, buoyed by record issuance in 2021 when ultralow rates and heavy private equity activity took the market by storm.

The Case for Bank Loans Still Exists

Beneath headline volatility lies a diversified set of issuers with negotiated protections, seniority in the capital structure, and a floating‑rate income profile that remains appealing even in a decelerating rate environment. Investors may not see a repeat of the asset class’s standout years between 2021 and 2023, when rising yields gave floating‑rate coupons a powerful tailwind. But the combination of elevated income, wide dispersion, and improving valuations supports a case for maintaining strategic exposure. That’s not to mention the argument that some of the loans that traded off were indiscriminately lumped in with truly troubled software business models facing AI disruption, even though their underlying fundamentals suggest greater resilience than the market implied.

Elevated yields remain one of the most compelling anchors for the asset class. The Morningstar LSTA US Leveraged Loan Index yielded 8.11% in April 2026, a top‑quartile yield relative to the index’s history dating back to 2002. While that’s down from the May 2023 peak near 11%, a byproduct of the Fed’s aggressive hiking campaign, income levels remain robust as the path of monetary policy has grown more uncertain.

Our Top Picks

Fidelity Floating Rate High Income FFRHX and T. Rowe Price Floating Rate PRFRX, which have Morningstar Medalist Ratings of Gold, exemplify the type of research‑intensive and risk‑aware approaches that can help investors navigate this environment.

Fidelity’s strategy benefits from long‑tenured lead manager Eric Mollenhauer and an accomplished supporting cast. The team has steadily reshaped the fund’s profile over time: Once one of the category’s more cautious options, it now more closely resembles a typical bank‑loan strategy but retains the liquidity discipline and measured approach to lower‑rated issuers that have long defined its process. Fidelity’s scale in the loan market provides advantages in sourcing, trading, and accessing deals that smaller competitors struggle to reach. These strengths translated into top‑quintile absolute and volatility‑adjusted returns over the trailing decade through April 2026.

T. Rowe Price’s offering rests on similarly sturdy foundations. Loan veteran Paul Massaro has cultivated a collaborative culture supported by a 20‑person leveraged‑finance credit research group, dedicated traders, and quantitative analysts. The team’s disciplined fundamental framework emphasizes BB and B rated loans and opportunistic access to second‑lien deals through long-standing private equity relationships.

Diversification guidelines help manage concentration risk, while the team’s focus on avoiding structurally weak credits has kept the fund’s volatility among the lowest in the category. That’s a big reason for its top-quintile Sharpe ratio over the trailing decade through April 2026.

This article first appeared in the April 2026 issue of Morningstar FundInvestor. Download a complimentary copy of FundInvestor by visiting this website.