Lower interest rates and piddly Treasury yields are among the reasons why some fixed income investors are embracing junk bonds and the related ETFs this year. Not to be left out of that conversation are leveraged loans and the Invesco Senior Loan ETF (NYSEArca: BKLN).
BKLN, the largest leveraged loan ETF, has been a bit of high-yield bond ETF laggard this year, rising just 3.58%, but the 5.10% yield is undoubtedly alluring for income-hungry investors.
Leveraged loans usually attract investors who are looking to generate income in a rising interest rate environment due to their floating rate component. However, central banks and agencies like the International Monetary Fund warned that credit quality is declining – bank loans are usual for highly leveraged companies and are rated speculative-grade.
“Fitch defines a senior loan as a commercial loan to a high-yield company provided by a group of lenders. Other names commonly used are bank loans, leveraged loans or syndicated loans,” according to Seeking Alpha. “These loans are typically senior secured debt (secured by the borrowing company’s assets) and are at the top of a company’s capital structure – i.e. they have a first lien on assets in the event of a bankruptcy.”
Betting On BKLN
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.
In other words, some investors may not feel compelled to avoid interest rate risk at a time when rates are declining. However, there are still reasons to consider BKLN, even when rates are falling.
“The rationale is that fixed rate assets are better positioned for falling rates than floating-rate loans. However, this thinking undervalues the critical long-term return drivers for senior loans,” according to Seeking Alpha. “The relatively high absolute coupon rates which are comprised of LIBOR plus credit spread and loans’ advantageous position within the capital structure mitigates the risk of credit loss.”
BKLN targets the S&P/LSTA U.S. Leveraged Loan 100 Index. That index “is designed to track the market-weighted performance of the largest institutional leveraged loans based on market weightings, spreads and interest payments,” according to Invesco.
For more information on the fixed-income space, visit our bond ETFs category.
The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.