Exchange traded funds continue to increase in number and popularity, growing to one of the most commonly traded securities on the stock exchange as both institutional and the average retail investor gain greater access to broad or specialized market exposure. Yet many individuals are unfamiliar with ETFs’ inner workings. In this ongoing series, we hope to address your questions and help shed light on the investment vehicle. [What is an ETF? — Part 28: CBOE Volatility Index (VIX)]
As investors search for yield generating assets, some have come across the senior bank loan ETF.
Senior bank loans are private debt instruments issued by a bank and provide capital to companies that typically fall below investment-grade credit ratings. As such, many investors have associated senior bank loans with speculative grade, or “junk,” bonds.
However, while senior loans may be rated below investment-grade, senior bank loans come with a little less risk since the notes are secured by collateral in the event of bankruptcy. If a company goes under, the loan is considered senior to all other claims – senior bank loan holders are first to be repaid, ahead of others, like creditors, preferred stockholders or common stockholders.
Typically, investors have utilized senior bank loans in a rising interest rate environment. As a floating rate instrument, senior bank loans can keep up with changes in interest-rates and are more stable compared to bonds over the long-run. Although rates are not on schedule to rise anytime soon, when they do, bank loan investors won’t have to aggressively reposition themselves.
“Funds that invest in floating-rate loans may be marketed as products that are less vulnerable to interest rate fluctuations and offer inflation protection, when in fact the underlying loans held in the fund are subject to significant credit, valuation and liquidity risk,” according to the Financial Industry Regulatory Authority Inc.