How Bank Loan ETFs Can Help Investors as Rates Rise

Broadly speaking, the first quarter was a dismal period for fixed income investors, and things may not get much better with the specter of as many as six more interest rate hikes looming over the course of this year.

However, not all bond segments are destined for failure as rates. Some are designed to thrive in these environments, including floating rate notes (FRNs). Of course, the trade-off investors make when embracing low-duration fare is low yields. Bank loans or senior loans are an avenue for trimming duration risk while maintaining exposure to credit opportunities.

The asset class is accessible via active and passive exchange traded funds, including the Invesco Senior Loan ETF (BKLN).

“Bank loans, or leveraged loans, are private loans taken out by companies from banks or a syndicate of lenders. The borrowers often carry credit ratings that are below investment grade. As such, they will often offer an extra yield to compensate for their credit risk,” notes Morningstar analyst Lan Anh Tran.

BKLN follows the S&P/LSTA U.S. Leveraged Loan 100 Index. The $5.53 billion ETF turned 11 years old last month, making it the elder statesman of the bank loan ETF category. Importantly, BKLN delivers when it comes to income. The Invesco fund sports a 30-day SEC yield of 3.25%, which is impressive considering interest rate risk isn’t an issue BKLN contends with.

Of course, bank loans aren’t the perfect asset class. As noted above, there is credit risk, and critics often note that liquidity isn’t always easy to source in this corner of the bond market. Covenant-lite loans are another point to ponder.

“This generally means fewer terms are in place to protect lenders. Most often, that means forgoing maintenance covenants that subject borrowers to regular financial tests. This could reduce recovery rates in the event of a default. The prevalence of covenant-lite loans has increased in recent years, as loose lending markets have made the market’s supply side more competitive,” adds Morningstar’s Tran.

Regarding liquidity, it’s true that bank loans aren’t as vibrantly traded as traditional corporate bonds, but that merely underscores the benefits of a product such as BKLN over selecting individual issues in this space. The fund holds 139 senior loans, indicating it’s unlikely that the entire basket would succumb to a major liquidity event at once. The fund also mostly steers clear of speculative CCC-rated debt as loans rated BBB, BB, and B combine for 94% of the portfolio.

For more news, information, and strategy, visit the ETF Education Channel.

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.

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