Against the backdrop of increasing borrowing costs, investors can utilize floating-rate, high-yield, senior loan exchange traded funds to hedge against a rising interest rate environment. That includes the actively managed SPDR Blackstone/GSO Senior Loan ETF (NYSEArca: SRLN).
Due to their floating rate component, bank loans are seen as an attractive alternative to traditional high-yield 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.
Senior loans, bank loans or leveraged loans may act as an attractive alternative. 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
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.
“In today’s tight credit spread environment, senior loans warrant consideration not only for their income generation opportunities but also for their ability to potentially mitigate cyclical credit risks and any negative effects from spread-widening,” said State Street in a recent note. “Since 1994, senior loans have outperformed high yield bonds by an average of 0.59% during months when credit spreads widened. In the 20 months in which spreads widened the most, senior loans had been impacted far less, generating negative performance that was above the lesser performing high yield asset class—ultimately preserving more yield in a portfolio’s speculative grade credit bucket.”
The actively managed bank loan ETF options could provide investors with better exposure as a manager is more freely able to weave in and out of the fixed-income market. For instance, Blackstone/GSO, which subadvises SRLN, is backed by one of the largest senior loan asset managers in the world.
“Senior loans offer a floating rate coupon that resets every three months, a structure that has allowed senior loans to outperform traditional fixed rate high yield in rate hike cycles like the one we’re in today. In the last three rising interest rate periods, senior loans have returned an average 6.5%, while high yield bonds have returned an average of just 2%,” according to State Street.