Banking on Senior Loans

10/06/2016 9:00 am EST

Focus: ETFs

David Fabian

Managing Partner, FMD Capital Management

Bank loans are debt instruments go by many different names, i.e. senior loans, leveraged loans, or floating rate notes. They are predominantly issued by companies with a below investment grade rating, and carry floating coupon rates, explains David Fabian, editor of The Flexible Growth & Income Report.

The coupon rate is typically indexed to a widely followed interest rate index, such as 3-month LIBOR.

One of the advantages of these floating rate securities is that coupon floors exist so as rates fall investors still receive respectable income. 

However, as interest rates rise, the commensurate coupon rate can also rise, which can increase the mark-to-market value of the security. 

Lastly, the effective duration is typically tied to the security’s reset rate, which is typically no longer than 60-90 days.

A widely-followed proxy for the bank loan market is the PowerShares Senior Loan Portfolio (BKLN). 

This ETF has $5.4 billion invested in an index of just over 100 loans using a market-cap weighted methodology. BKLN has a 30-day SEC yield of 5.45% and income is paid monthly to shareholders.

Two other available options are the SPDR Blackstone / GSO Senior Loan ETF (SRLN) and First Trust Senior Loan Fund (FTSL). 

Both of these ETFs are actively managed funds with a broader number of holdings and over three years of trading history.

We opted to purchase a starter position in FTSL in our Strategic Income Portfolio after a thorough analysis of the strengths and weaknesses each fund brings to the table. 

Primarily, we believe that the broader diversification, credit research, and flexibility of an active fund is an advantage in this unique sector. 

Make no mistake – bank loans are not a panacea for the specter rising interest.  These loans still carry noteworthy credit risk, similar to high yield bonds. 

FTSL has been one of the better performing funds over the last several years and currently carries an outsized cash position that we believe will be an advantage moving forward.

In our opinion, the relative under performance of bank loans this year combined with the potential for a sideways to uptrend in interest rates offer an attractive opportunity.

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By David Fabian, Editor of The Flexible Growth & Income Report

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