With Federal Reserve rate hike speculation rising and interest rates inching higher, fixed-income investor should take a look at senior secured bank loan-related exchange traded funds to generate yields and diminish rate risks.
For instance, investors can take a look at the passive index-based PowerShares Senior Loan Portfolio (NYSEArca: BKLN) and Highland/iBoxx Senior Loan ETF (NYSEArca: SNLN). 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).
The actively managed AdvisorShares Pacific Asset Enhanced Floating Rate Note ETF (NYSEArca: FLRT) hit the markets in February. [New Active ETF Seeks Income With Floating Rate Loans]
Senior bank loans are a type of debt financing obligation issued by a bank. The loan is considered senior to all other claims against the borrower, so it receives priority in the event of a bankruptcy. Additionally, since the senior loans have rates that adjust periodically, the floating-rate loans offer investors an alternative method of earning yields with little or no interest-rate risk. The senior loans are typically pegged to the London Interbank Offered Rate, or Libor, with the current three-month rate at about 0.25%, writes Rick Roberts for Financial Advisor.
Due to their floating rate component, bank loans are seen as an attractive alternative to traditional corporate bonds in a rising rate environment. Bank loan securities allow their interest rate to shift, or float, along with the rest of the market, whereas a fixed interest rate stays constant until maturity. For instance, BKLN adjusts its floating component on an average 36.9 days. SNLN adjusts an average 37.4 days. SRLN resets 35 days. FTSL has a 39.4 day reset period.
In contrast, bond funds with long durations will pull back as interest rates rise. The benchmark 10-year Treasury yield rose 13 basis points to 2.24% Friday on speculation that the Federal Reserve would hike rates after the better-than-expected February jobs report.
Investors should be aware that they are still exposed to credit risk as the majority of underlying bank loan holdings are rated speculative-grade or junk. However, an actively managed bank loan ETF option could provide investors with better exposure as a manager is more freely able to weave in and out of the fixed-income market. [Active ETFs Help Drive First Trust’s Growth]
On the flip side, investors are rewarded with higher yields. For example, BKLN has a 4.04% 30-day SEC yield, SNLN has a 4.04% 30-day SEC yield, SRLN has a 4.06% 30-day SEC yield and FTSL has a 4.49% 30-day SEC yield.
For more information on the fixed-income market, visit our bond ETFs category.
Max Chen contributed to this article.