Investors Shouldn't Be Ditching This Bond ETF

Though there have been bumps along the way, when the PowerShares Senior Loan Portfolio BKLN debuted in early 2011 it spent significant time as a compelling option for fixed income investors looking to access respectable, even high, yields in a low interest rate environment.

That popularity made the PowerShares Senior Loan Portfolio the largest exchange traded fund tracking senior loans, also known as bank loans, in addition to being the first ETF to offer investors exposure to the asset class. With advisors and investors reconfiguring their expectations for changes in Federal Reserve interest rate policy, BKLN has been repudiated, but there are reasons to believe recent treatment of the ETF has been far too harsh. In fact, some data suggest this is an ETF that should not be ignored even interest rates do rise.

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.

Part of the reason advisors and investors have recently eschewed BKLN is because the ETF easily qualifies as a high-yield offering. A 30-day SEC of over 6 percent confirms as much as does a lineup that devotes 91 percent of its combined weight to bonds rated BB, B or CCC. Fortunately, BKLN's allocation to CCC-rated bonds, one of the worst-performing corners of the junk bond market this year, is just 4 percent.

BKLN holds the “100 largest bank loans with floating rate coupons. Unlike fixed-rate instruments, the coupons of floating rate bank loans adjust upward as interest rates rise – providing investors with the potential of an attractive source of current income,” according to PowerShares.

The ETF has suffered nearly $1.5 billion in outflows this year, a total exceeded by just one other PowerShares ETF. So it would appear that BKLN is a contrarian fixed income idea. Not only that, but the timing for considering this ETF could be good because senior loans are not as rate-sensitive as some investors perceive the asset class to be.

“Senior loans, also known as bank loans, are generally structured with floating rate coupons based on a spread over 90-day Libor. As such, interest rate risk tends to be measured by the number of days until the next rate reset, rather than the more traditional measure of duration used for fixed rate investments. Investors who are looking for exposure to high yield bonds, but are concerned about rates might prefer senior loans — most senior loans are to issuers rated below investment grade, yet these instruments have very low interest rate exposure,” said PowerShares in a note out today.