Speculation that the Federal Reserve will almost certainly boost interest rates next month is prompting some investors to turn to floating-rate bank loans and related ETFs to hedge against rising rate risks.
More fixed-income investors are turning to senior secured floating rate bank loans as a way to hedge rising rate risks and still generate yields. The influx into the senior loan portfolio suggests that investors are growing wary of a potential Fed rate hike and want to position their fixed income portfolios accordingly.
The popular PowerShares Senior Loan Portfolio (NYSEArca: BKLN), the largest senior loan-related ETF on the market, and rival bank loan ETFs have recently been on the receiving end of fresh capital from yield-seeking investors.
“U.S. leveraged loan funds recorded an inflow of $1.12 billion in the week ended Nov. 23, according to the Lipper weekly reporters only. That nearly doubles the $673 million from the prior week and marks the largest inflow into the asset class since the week ended Sept. 18, 2013 ($1.33 billion),” reports LeveragedLoan.com.
A senior loan is a private loan taken from an underwriting bank or a syndicate of lenders. The loans are secured in that they are backed by the borrowers’ assets, which act as collateral. If the borrower defaults, lenders have a senior claim on the defaulters’ assets. Moreover, senior secured floating-rate loans have, as their name suggests, a floating interest rate component, which fluctuates with market rates.
SEE MORE: Inside Floating Rate ETFs
Since rates are typically reset once per quarter, senior loans typically have low durations – a measure of a bond fund’s sensitivity to changes in interest rates. The floating-rate component also offer investors an alternative method of earning yields while mitigating interest-rate risk. Consequently, bank loans are seen as an attractive substitute to traditional corporate debt in a rising rate environment.
“Loan funds have been on a tear in the second half of the year. Inflows were recorded in 19 of the last 22 weeks for a total inflow of $5.78 billion during that span. Over the first 26 weeks of 2016 the cumulative outflow was $5.565 billion, with 18 negative weeks against just eight positive readings,” according to LeveragedLoan.com.
PowerShares Senior Loan Portfolio (NYSEArca: BKLN)