Uncertainty On The Rise For Bank Loan ETFs

Bank loan ETFs gained a great deal of notoriety and assets last year as investors flocked to these non-traditional debt securities in order to insulate their portfolio from rising interest rates.  Floating rate notes and senior loans are unique in that their yield is tied to a benchmark such as LIBOR, rather than being fixed.  

Loans are also higher on the capital structure than other unsecured obligations, and some even carry floors to insure you earn a respectable yield even if rates stay low.  Their coupon rate typically resets every 90-days, resulting in a duration shorter than three months.

The PowerShares Senior Loan Portfolio (BKLN) gained nearly $5 billion in new inflows in 2013 as investors worried over the Fed’s long-term exit strategy from quantitative easing.  That demand initially carried forward into 2014 as well, but we are starting to see some recent outflows that may spark additional questions for ETF investors.  

According to ETF.com, BKLN has seen net redemptions of $74.5 million in May.  This marks the second straight month of coordinated outflows as long-term interest rates have continued to fall and traditional fixed-income securities become more attractive.

One concern for ETF investors in this space is the liquidity of the underlying securities in the event that additional selling picks up.  Bank loans are notorious for their illiquid markets that often lead to long settlement times and unconventional trading practices.  

In addition, income seekers must keep in mind that you are sidestepping interest rate risk in favor of credit risk with bank loans because most are rated below investment grade.  A flight from credit sensitive investments to quality holdings may also result in a shakeup of this sector.  

Other notable ETFs in this space that may be affected include the SPDR Blackstone GSO Senior Loan Portfolio (SRLN) and First Trust Senior Loan Fund (FTSL).  

While it’s important to understand these risks, each of these ETFs has also continued to provide steady income and stable price action in relation to the senior loan market.