Amid liquidity concerns, bank loan, or senior loan, exchange traded funds have taken some lumps this year, but with fears of higher interest rates still prominent, investors should not ignore this once beloved corner of the fixed income market.
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. Due to their floating rate component, bank loans are seen as an attractive alternative to traditional corporate bonds in a rising rate environment.
The interest rate flexibility offered by ETFs such as the PowerShares Senior Loan Portfolio (NYSEArca: BKLN) and the SPDR Blackstone/GSO Senior Loan ETF (NYSEArca: SRLN) and the Highland/iBoxx Senior Loan ETF (NYSEArca: SNLN) has been displayed during previous spikes in ten-year year Treasury yields. [Bank Loan ETFs Back in Style]
For example, in 2013, BKLN returned 4.1% while SRLN, which debuted in the second quarter of that year, gained 1.8% while the iShares 20+ Year Treasury Bond ETF (NYSEArca: TLT) and the Vanguard Total Bond Market ETF (NYSEArca: BND) lost 13.4% and 2.1%, respectively. Interestingly, bank loan ETFs like BKLN, SRLN and SNLN hold high-yield bonds, but that did not lead to increased volatility when Treasury yields surged two years ago.
Volatility for BKLN and SRLN in 2013 averaged just 1.75% while TLT’s volatility was 13.1%. The 2013 volatility on the iShares iBoxx $ High Yield Corporate Bond ETF (NYSEArca: HYG) was 6.2%, according to ETF Replay data.
Lower default rates could continue supporting bank loan ETFs.
“U.S. corporate profits are largely solid and balance sheets are generally cash-rich. In addition, moderate leverage should help issuers meet their debt obligations. Against this backdrop, we expect floating rate default rates to remain lower this year than their historical average, and at far lower levels than what’s currently being imputed in the marketplace,” said Neuberger Berman in a note out earlier this week.
The research firm notes that the credit quality of new bank loan issues coming to market is increasing. In the first quarter, 40% of newly issued senior loans were rated B, BB or higher, up from 30% in 2013 and 2014. [Reconsidering Bank Loan ETFs]
Over the past year, investors have consistently pulled money from senior loan funds, indicating that they did not believe a Fed rate hike was imminent. However, the interest rate outlook is changing and that could lead investors back to BKLN and rival ETFs. However, those outflows may not last long and there are catalyst that suggest inflows to bank loan ETFs could be renewed.
“Moving forward, we see the potential for an increase in retail demand: Yields from foreign sovereigns are depressed or in negative territory, and additional quantitative easing in the eurozone and Japan is likely to keep their rates low, making loan yields more attractive by comparison. In the U.S., the Fed’s potential rate increases could draw investors to loans, both for security and as their yields become more attractive,” said Neuberger Berman.
PowerShares Senior Loan Portfolio
