Bank loan ETFs have weathered the recent turbulence in interest rates relatively well as investors try to guess the Federal Reserve’s next move on quantitative easing.
While many have steered toward bank loans as a rate hedging tool, don’t forget that the assets are still speculative in nature.
Brian Frederick, a principal at Stillwater Financial Partners, among others, argues that bank loans can be even riskier than junk bonds, reports Constance Gustke for CNBC.
“These companies have a hard time even issuing junk bonds,” Frederick said in the article.
Bank loans funds are comprised of loans to corporations made by banks and other financial institutions. These debt securities are typically rated speculative grade, or considered “junk.”
Allan Roth, founder of advisory firm Wealth Logic, believes that investors shouldn’t forgo more credit risk for less interest rate risk.
“Between credit risk and interest rate risk, boy, I would I rather take on rate risk,” Roth said in the article. “Interest rate risk, you lose the opportunity cost of yield; credit rate risk, you lose everything.”
“Perhaps the largest risk to bank loans is the potential for a U.S. recession in the near future,” Morningstar analyst Timothy Strauts explained. “While this is not expected by the majority of surveyed economists, current federal spending cuts will have a negative impact on GDP growth in the near term. A recession could increase defaults in the bank-loan sector, which would depress the prices of loans.”