With the bank loan market in focus this year because of weakness in the broader corporate bond space, investors looking to tap this high-yielding asset class may want to consider doing so via active management, the style of the SPDR Blackstone/GSO Senior Loan ETF (NYSEArca: SRLN).

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.

“While senior loans may be suitable for some investors, they are very illiquid, so they aren’t well-suited for index investing,” said Morningstar analyst Neal Kosciulek in a recent note. “These private loans are not registered with the SEC and can be challenging to trade; they tend to trade infrequently, in small amounts, and often have large spreads. And it can take weeks for trades to settle. Consequently, the fund must hold positions in cash or liquid bonds to provide daily liquidity.”

Sizing Up SRLN

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 offers investors an alternative method of earning yields while mitigating interest-rate risk. Consequently, bank loans are seen as an attractive substitute for traditional corporate debt in a rising rate environment.

Senior loans can be “sensitive to changing credit spreads, given the low credit quality of its issuers, though not to the same extent as the broad high-yield bond market because its loans are secured,” notes Morningstar’s Kosciulek.

SRLN invests in senior loans given to businesses operating in North America and outside of North America. The Portfolio may invest in senior loans through the loans directly via the primary or secondary market or via participation in senior loans, which are contractual relationships with an existing lender in a loan facility where the loan portfolio purchases the right to receive principal and interest payments.

By including senior loans in SRLN’s portfolio, the loans first lien priority, meaning in the event of a borrower default, the senior loans are paid first. Higher payment priority assists liquidity in terms of the defaulting borrower having to sell assets in order to pay off creditors–in this case, senior loans within the SRLN portfolio are given higher priority–a viable option, especially during a market downturn.

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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.