Bank Loan ETFs: The Effects of an Illiquid Underlying Market | ETF Trends

Fixed-income exchange traded funds have become more liquid than their underlying markets as more investors turn to the easy-to-use investment tool. However, sudden changes in market sentiment could cause price disparities with the underlying assets, like what is happening with bank loan-related ETFs.

For instance, passive index-based PowerShares Senior Loan Portfolio (NYSEArca: BKLN), the largest bank loan ETF on the market with $6.1 billion in assets under management, has dipped 1.7% since the end of June while the benchmark S&P/LSTA U.S. Leveraged Loan 100 Index only fell 0.9%, reports Lisa Abramowicz for Bloomberg.

BKLN is trading at a 0.54% discount to its net asset value, according to Morningstar data. The ETF has been trading at an average discount to the underlying index for the past year, the longest period in its history. [Fixed-Income Traders Increasingly Rely on Junk Bond ETFs]

The disparity between the ETF price and its benchmark suggests that the ETF market may be more liquid than the underlying high-yield, junk bond market, which isn’t really surprising as ETFs are traded daily like a stock on an exchange and would reveal more immediate price moves than bond securities. [Rate Risk Raises Liquidity Concerns in Junk Bond ETFs]

“Fixed-income ETFs are oftentimes a better reflection of where the underlying pricing might be headed,” John Hoffman, Invesco PowerShares’ global head of ETF capital markets, said in the Bloomberg article. “It’s trading in more real time than the underlying components.”

Year-to-date, BKLN only gained 0.2%, whereas the Highland/iBoxx Senior Loan ETF (NYSEArca: SNLN), which tracks the Markit iBoxx Liquid Leveraged Loan Index, increased 1.4%. There are also two actively managed options, including the SPDR Blackstone/GSO Senior Loan ETF (NYSEArca: SRLN) and First Trust Senior Loan ETF (NasdaqGM: FTSL). Year-to-date, SRLN gained 0.9% and SRLN rose 1.8%.