As widely expected, the Federal Reserve raised interest rates earlier this week, setting the course for several more rate hikes in 2018 and beyond. Rising rates do not damage all fixed income investments, and some exchange traded funds are dedicated to corners of the bond market that can thrive as borrowing costs climb.
The SPDR Blackstone / GSO Senior Loan ETF (NYSE:SRLN) is an actively managed fund focusing on senior loans. Senior loans, also known as floating rate bank loans, have floating rate components, which diminishes interest rate risk.
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A senior loan is senior to all unsecured claims against the borrower and senior or equal to all other secured claims, meaning that, in the event of a bankruptcy, the senior loan, together with other first lien claims, is entitled to be the first to be repaid out of proceeds of the assets securing the loans, before other existing claims or interests receive repayment, according to State Street Global Advisors.
In addition to seniority in event of issuer default and lower rate risk, senior loans have some other perks.
Like high yield, senior loans have the potential to generate elevated levels of income because they are deemed to be speculative-grade credit, SSgA saidin a recent note.
Senior loans can generate that elevated level of income while providing a far lower duration than high yield. By bringing in duration and sitting higher in the capital structure, senior loans may be able to navigate late cycle credit dynamics (rising rates, increased leverage, more downgrades) better than a traditional high yield allocation. These advantages may become more pronounced in the current rising interest rate environment.
SRLN has nearly 310 holdings with a 30-day SEC yield of 4.25 percent. That is a lower yield than what investors will find with traditional junk bond ETFs, but it's the trade-off for SRLN's reduced sensitivity to rising interest rates.
Not A Free Lunch
Free lunches do not exist in financial markets, and SRLN is no exception. The risk with this ETF is credit risk, as about 80 percent of its holdings are rated BB-, B+, B or B-. Nearly 4 percent of SRLN's holdings sport speculative CCC ratings.
Still, SRLN can offer investors income and portfolio diversification, as senior loans are usually not highly correlated to Treasuries, traditional corporate bonds or equities, according to SSgA data.
The Federal Reserve building in Washington, D.C. Photo by AgnosticPreachersKid/Wikimedia.
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