As the markets anticipate a higher likelihood of a Federal Reserve interest rate hike before the year’s end, it may be a good time to revisit senior floating-rate bank loans exchange traded fund strategies.
A Senior loan is a private loan a firm takes from a bank or a syndicate of lenders. The loans are backed by the borrowers’ assets, which act as collateral. If the borrower defaults, lenders have a senior claim on the defaulters’ assets
While senior loans are rated below-investment grade, default rates on senior loans have historically been slightly below those of high-yield or junk bonds.
“The correlation of bank loans has been historically and consistently low versus other asset classes through different credit and rate cycles,” according to Highland Capital Management.
Moreover, senior loans have a floating interest rate, which fluctuates with market rates. Because rates are typically reset once per quarter, senior loans come with low durations. Since the senior loans have rates that adjust periodically, the floating-rate loans also offer investors an alternative method of earning yields while mitigating interest-rate risk. Consequently, due to their floating rate component, bank loans are seen as an attractive substitute to traditional corporate bonds in a rising rate environment.