Rising Rate Ideas: Senior Loan ETFs

MarketsETF Trends

This article was originally published on ETFTrends.com.

With rising interest rates widely expected to continue this year, some fixed income strategies and exchange traded funds merit additional consideration. That includes senior loans and the actively managed SPDR Blackstone/GSO Senior Loan ETF (NYSEArca: SRLN).

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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, 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

Senior loans usually have below investment-grade ratings, but there are important differences betweent these bonds and traditional junk bonds.

“While their credit quality is often below investment grade, similar to high yield, senior loans are ahead of high yield debt in the event of issuer default,” said State Street Global Advisors (SSgA) in a note out Tuesday. “This means senior loans have a higher recovery rate than traditional high yield bonds, making them potentially less risky than high-yield bonds issued by the same company. This is illustrated by loans outperforming high yield fixed rate debt by 57 bps in months when credit spreads have widened out, based on return date from 1994 to 2017.”

A Closer Look at the SRLN Senior Loan ETF

The $2.64 billion SRLN has 310 holdings and a 30-day SEC yield of 4.15%. Nearly two-thirds of the ETF's lineup carries credit ratings of B+, B or B-.

“Rising interest rate cycles are supportive of senior loans because these loans offer a floating rate coupon that resets every three months. Add this to their seniority in the capital structure and the drawdowns in the most recent sell-off were not as severe,” according to SSgA.

Related: Combine Active, Passive ETFs to Make a Stronger Portfolio

Additionally, senior loans come with significant liquidity risks – senior loans do not come with a maximum settlement period, which may cause trouble for funds that try to redeem senior loans during more volatile periods. Fund providers, though, may stick to more liquid segments of the senior loan market and hold cash to help offset this risk.

For more information on floating rates, visit our floating rate notes category.

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