An Asset Class For Rising Rates

While there is considerable debate regarding the Federal Reserve's plans for interest rates this year, advisors and investors are still examining asset classes that could benefit from increased borrowing costs.

Senior Loans, Bank Loans

That list should include senior loans or bank loans, an asset class accessible via several well-known exchange traded funds, including the SPDR Blackstone/GSO Senior Loan ETF (SSGA Actice ETF Trust) SRLN.

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.

“Rising interest rates cycles are supportive of senior loans because their interest rates are benchmarked to LIBOR, plus a spread to compensate for credit risk. Senior loans’ coupons adjust and adopt a floating rate structure once LIBOR (typically the 1-month or 3-month term) has surpassed the 'floor,' which is usually 75bp or 100bp respectively,” according to State Street Global Advisors (SSgA).

What Makes SRLN Special?

The actively managed SRLN, which has nearly $1.3 billion in assets under management, has LIBOR floors on 90.6 percent of its 257 holdings, according to issuer data.

The combination of investors' ongoing search for yield and favorable supply/demand dynamics are potential catalysts for ETFs such as SRLN.

“Retail investors are also turning to loans to potentially insulate portfolios from rising rates. Lastly, CLO generation ended 2016 with a very strong fourth quarter and should add to the strong demand for senior loans,” noted SSgA. “Given that the size of the senior loan market has been nearly stagnant for two years, growing only 6 percent from 2014 through 2016, this supply/demand imbalance is creating strong demand trends for senior loan funds in 2017.”

For the week ended Feb. 8, leveraged loan funds, of which SRLN is one, added $855 million in new money, extending the string of inflows for the group to 26 of the past 27 weeks, according to S&P Global Market Intelligence.

Over 80 percent of SRLN's holdings are rated between B and BB+. The ETF has a 30-day SEC yield of 3.76 percent.