Leveraged Loan ETFs Can Provide Stable Income Generation

Exchange traded fund investors should consider the diversification benefits of including senior loan strategies in an investment portfolio.

In the recent webcast, Loans, An All-Weather Asset Class, George Goudelias, Head of Leveraged Finance, Senior Portfolio Manager, Seix Investment Advisors, explained that leveraged loans deliver competitive returns per unit of risk, which takes into account the degree of risk that must be accepted in order to achieve a return. Specifically, leveraged loans have exhibited a 1.0 return per unit of risk over the past decade, compared to a 0.7 return per unit of risk for large cap equities.

The leveraged credit market has also historically offered the best relative value. Leveraged loans currently show a 4.9% yield, compared to 4.2% for high-yields, 2.3% for investment-grade corporates, and 1.9% for tax-equivalent munis.

In rising interest rate environments, leveraged loans posted positive returns in 18 out of 18 periods over the past two decades. For example, in the recent period between August 2020 and March 2021, the Credit Suisse Leveraged Loan Index posted a 6.4% return, whereas the Bloomberg Barclays Aggregate Index declined by 2.8%.

Even if interest rates do not rise, leveraged loans can still hold up, exhibiting a rather rate-agnostic characteristic, Goudelias added.

Inflation has also been a recent worry, especially in the context of fixed income assets. However, leveraged loans have shown high correlation with inflation. Specifically, leveraged loans showed a positive 0.32 correlation to inflation over the past two decades, compared to long-government bonds’ -0.23 correlation to inflation.

To help investors focus on the leveraged loan category, David Phipps, Senior Leveraged Finance Research Analyst, Seix Investment Advisors, highlighted the actively managed Virtus Seix Senior Loan ETF (NYSEArca: SEIX). SEIX seeks to provide investors with a high level of current income via first- and second-lien senior floating rate loans.

Phipps also highlighted the firm’s commitment to environmental, social, and governance, or ESG, goals.

“The investment process has been driven by bottom-up credit analysis that relies on our five core investment tenets. Building on proprietary systems developed in our early years to ensure compliance with SRI client guidelines, we integrated the review of ESG factors into our existing credit process,” Phipps said.

Senior loans are typically used for business recapitalizations, acquisitions, leveraged buyouts, and re-financing. Phipps explained that leveraged loans have offered the potential for higher income and lower correlations to other fixed income asset classes, and, though they may potentially provide a hedge against rising interest rates, they have historically performed well in periods with stable interest rates.

Phipps added that the Seix leveraged loan investment philosophy emphasizes BB-and B-rated loans, seeking to invest in the healthiest and most undervalued credits in the non-investment grade space.

Financial advisors who are interested in learning more about senior loan strategies can watch the webcast here on demand.