Bank loan, or senior loan, exchange traded funds have garnered an impressive following in recent years due to attractive yields and the funds’ ability to remain durable in rising interest rate environments. However, understanding how those yields and interest durability are delivered are important considerations.
One way of looking at bank loans is that they are floating rate products because the rates on the loans are reset every month or two months. That helps keep duration low. The current market environment seems to be right in bank loan ETFs’ wheelhouse as investors clamor for income while also guarding against the negative impact of rising rates.
“The first thing to understand about the floating-rate nature of bank loans is that their yields “float” along with Libor (the London Interbank Offered Rate), not the more widely watched 10-year Treasury yield or federal-funds rate. Libor represents the rate at which the major banks can borrow from each other in the London interbank market over various time periods, ranging from overnight to one year,” according to a recent Morningstar note.
The $5.7 billion PowerShares Senior Loan Portfolio (NYSEArca: BKLN) has a three-month LIBOR rate of 0.28% as does the $678.3 million SPDR Blackstone/GSO Senior Loan ETF (NYSEArca: SRLN). [Bank Loan ETFs Back in Style]
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.
Investors, though, should not forget that senior bank loans are denoted high-yield because the issuing firms are highly leveraged, and highly leveraged companies are more at risk of default and bankruptcy. Nevertheless, these bank loans are slightly safer than traditional high-yield bonds since they are secured by collateral and have historically shown lower default rates. [Enduring Appeal of Bank Loan ETFs]