Senior loans are gaining ground as investors seek higher yields in a low interest rate environment while seeking to hedge against rising inflation. Exchange-traded funds holding these debts can offer diversified exposure to the asset class, but investors looking to participate in the stock should consider going active or passive.
Senior loans are issued by banks to speculative grade companies and then sold to investors. These variable rate loans generally offer higher yields than higher quality bonds, but lower yields than undesirable rated bonds, because bank loans are more âseniorâ in the capital structure. If the company were to default on its debt, senior loan holders would be repaid first, often with guaranteed collateral such as property or equipment.
Senior loans look particularly attractive this year because of these variable rates. With the Federal Reserve cutting short-term interest to near zero and pumping hundreds of billions of dollars into the economy, there has been a noticeable increase in inflation, and many expect interest rates to rise. higher accordingly. Variable rate debt can adapt to this environment and therefore offers some protection against rising interest rates. (Bond prices fall when yields rise.)
Attracted by the combination of higher yields and lower rate sensitivity, investors have pumped $ 32 billion into senior loan mutual funds and ETFs so far this year, bringing the total assets of the group to more than 106 billion dollars. ETFs, in particular, nearly doubled their asset base to $ 17 billion. ETFs might be a better choice than mutual funds, says Todd Rosenbluth, head of ETF and mutual fund research at CFRA, because they are traded in the open market and therefore offer better liquidity to the market. otherwise less liquid asset class.
The $ 6.7 billion
Invesco Senior Loan
ETF (ticker: BKLN), for its part, prioritizes liquidity. âThe settlement period for negotiating senior loans can sometimes stretch over weeks, [and] this can be difficult for institutions that require immediate liquidity, âsaid Jason Bloom, US head of fixed income strategies for Invesco. As the second-largest ETF in the industry, the fund aims to replicate the performance of the 100 biggest senior loans, but it also holds more liquid cash and high yield bonds to ensure it can meet the demand for repayment. investors.
The $ 7.6 billion
SPDR Blackstone Senior Loan
ETF (SRLN), which recently became the largest ETF in the industry, was favored by investors this year thanks to its better performance. The actively managed fund has returned 4.3% year-to-date, almost double that of the Invesco Index ETF. He has also beaten his peers in the last periods of one, three and five years.
âThe advantage of active management is that you can sort the universe and determine where pricing errors may occur and which obligations are most likely to be improved,â says Rosenbluth. This could be especially useful in a less efficient market like senior loans.
Much of the SPDR fund’s outperformance can be attributed to its deeper reach into the credit quality ladder, which offers higher returns but also higher risk. It’s an intentional choice, says Dan McMullen, senior portfolio manager at Blackstone, because his team believed that the lower-grade debt was oversold last year and the risk of credit default would decrease. In 2020, the fund also underweight the sectors most affected by Covid-19, such as airlines and cinemas, he says, which helped avert some losses.
Nonetheless, the data suggests that over a longer period, over 90% of actively managed funds in the loan category underperformed the benchmark. The SPDR ETF has had an excellent track record so far, but the future is yet to be proven.
Write to Evie Liu at [email protected]