Because they invest in floating-rate bank loans taken on by corporations, bank-loan funds have very little interest-rate risk. They yield more than other options listed so far, with the potential to go higher if rates rise.
The big thing to worry about is borrowers defaulting. When the economy is humming along, that's not much of a problem. And even when the economy does slow, banks are among the first creditors in line when a business goes belly up. Companies that have defaulted so far have made good on their floating-rate loans more than 80% of the time; distressed junk bonds haven't done half as well.
When shopping for a bank-loan fund, beware of high costs. Many funds charge back-end loads if you don't stay in for a minimum time (typically, at least a year). Further, their expense ratios are often higher than the average bond fund's.
Bank-loan funds work best for investors who will need to draw on the money at a predictable time. Because most bank-loan funds allow investors to redeem their shares only once each quarter, they aren't good places to keep money you might need in an emergency. So if you sock money away for that trip to Europe in a bank-loan fund, be sure to withdraw far enough in advance.
For more about bank-loan funds, take Funds 407: Using Quirky Bond Funds.