A Post-Fed ETF Idea

To little surprise, the Federal Reserve did not raise interest rates when the Federal Open Market Committee (FOMC) met Wednesday. If there were any surprises, it is that the Fed appears to be on course for just two interest rate increases this year, half the number many market participants were forecasting entering 2016.

While the Fed reaffirmed its commitment to depending on U.S. economic data to chart the course for interest rates, fixed income investors still face uncertainty. That uncertainty comes at a time when U.S. government and high-yield corporate bond exchange-traded funds have been among investors' favorite destinations.

Related Link: A Rare Opportunity With A Biotechnology ETF

“Without a clear roadmap, the US central bank will need to determine if mixed economic data indicates the US economic recovery is on track—or if volatile oil prices, dim global inflation prospects and slowing growth in China have stalled the US growth engine. Now, though the Fed has hiked rates once and had forecasted more in 2016, the fate of future hikes has become so murky that economists’ interest rate forecasts for 2016 are all over the map,” said State Street Vice President David Mazza in a new note.

Does Opportunity Still Exist?

Although the Fed is being as ambiguous as ever with its plans for interest rates, there is some opportunity with rate-sensitive asset classes such senior loans. Also known as bank loans, this high-yield asset class can be accessed by several ETFs, including the actively managed SPDR Blackstone/GSO Senior Loan ETF (SGA Actice ETF Trust SRLN).

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, Benzinga reported earlier this year.

Senior loans also place higher than most high-yield bonds in the pecking order for creditors in the event of issuer default.

“Senior loans, which are senior to most high yield bonds in the corporate credit structure, have the potential to generate higher income with less exposure to unpredictable volatility in high yield bonds,” added Mazza.

Although senior loans have advantages, that does not mean investors take on unnecessary risk or expose themselves to extremely low credit quality with an ETF like SRLN.

Neither is a major concern with SRLN, because the ETF is lightly allocated to troublesome CCC-rated debt. Junk bonds rated CCC and lower have been the high-yield market's worst performers this year. SRLN allocates barely more than 3 percent of its combined weight to bank loans rated CCC+ and CCC. Over three-quarters of SRLN's lineup is rated B, B+, BB- and BB.