Senior Loan ETFs Pros & Cons...

Some fixed income strategies and ETFs can offer investors protection from rising interest rates, but there are consideration with these funds. That includes senior loans and 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 enjoy seniority in the capital structure, helping to mitigate drawdowns during risk-off events compared with traditional fixed rate high yield,” said State Street Global Advisors (SSgA) in a recent note. “They also tend to exhibit lower equity correlation than fixed rate high yield and exhibit negative correlation to traditional bond segments, like Treasuries and corporate bonds, helping to improve overall portfolio diversification.”

With interest rates climbing, ond investors may consider substituting credit risk for interest-rate risk to earn higher returns. For example, 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.

Sizing Up SRLN

SRLN holds non-investment-grade debt, but senior loans offer some advantages over traditional junk bonds, such as “senior loans, represented by the S&P/LSTA U.S. Leveraged Loan 100 Index, are less volatile than their fixed income counterparts, including high yield bonds and emerging market debt,” according to SSgA. “In addition, they’ve exhibited less volatility than large-cap, small-cap and emerging market stocks.”

The actively managed SRLN, which debuted in April 2013, holds 312 bonds with a weighted averaged days to reset of 27 days.