Why Active Management Works For This ETF

There is plenty of data supporting the notion that passive funds, including exchange traded funds, over time, deliver superior performance relative to actively managed equivalents. The fixed income universe is not an exception to that rule and the recent imbroglio surrounding a Third Avenue Management junk bond fund shows that just because a fund is actively managed does not mean it is immune from high stress situations.

While data also support the fact that most active high-yield bond fund managers consistently trail their benchmarks, there are some corners of the bond world where active management can be an advantage, including senior loans. The SPDR Blackstone/GSO Senior Loan ETF SRLN is one of the actively managed solutions to this asset class.

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, Benzinga reported earlier this year.

Even with all the hype surrounding the negative impact higher U.S. interest rates can have on high-yield bonds, SRLN, home to nearly $777 million in assets under management, is off just 1.3 percent this year. The ETF's 30-day SEC yield is 4.13 percent. As the Third Avenue flap taught investors, active management is not a guarantee a bond fund will avoid risky credits, but in the case of SRLN, the fund does just that.

“Credit selection is one of the most important determinants of a portfolio’s risk and return. Active managers can act to avoid weak or failing senior loans that might be included in a passive approach, potentially reducing a fund’s risk. An active manager can also purchase loans that may have attractive fundamentals, but are not included as part of the 100 largest or most liquid loans in the major indices, potentially enabling superior risk-adjusted returns,” said State Street Global Advisors Vice President David Mazza in a recent note. 

A scant percentage of SRLN's holdings are rated in the troublesome CCC group. Close to 90 percent of the issues held by the ETF are rated somewhere between B+ and BBB, according to issuer data. 

“Through rigorous security selection, an active management approach has the potential to avoid particular loans that are no longer of good quality and may be considered distressed. Relative to the S&P/LSTA U.S. Leveraged Loan 100 Index, SRLN's portfolio has a higher allocation to securities that have not seen their value decline,” adds Mazza.

As Mazza previously noted, senior loans have had a vastly superior recovery rate over the past two decades than traditional junk bonds.