An Active Idea For Income And Yield

With the possibility of another interest rate hike or two looming in the United States and negative interest rates still lingering in other parts of the developed world, the fixed income landscape is trying investors that are searching for income.

A growing number of exchange-traded funds allow investors to find unique sources of income and yield while finding ways to manage interest rate risk. That group of ETFs includes the actively managed SPDR Blackstone / GSO Senior Loan ETF SRLN.

Actively Managed ETFs: Looking Closer At 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.

Environment For Success?

“In today’s tight credit spread environment, senior loans warrant consideration not only for their income generation opportunities but also for their ability to potentially mitigate cyclical credit risks and any negative effects from spread-widening,” said State Street Global Advisors (SSgA) in a recent note.

Historical data indicate widening credit spreads lead to senior loans outpacing traditional junk bonds.

Not Your Common Junk

“Since 1994, senior loans have outperformed high yield bonds by an average of 0.59 percent during months when credit spreads widened,” according to SSgA. “In the 20 months in which spreads widened the most, senior loans had been impacted far less, generating negative performance that was above the lesser performing high yield asset class — ultimately preserving more yield in a portfolio's speculative grade credit bucket.”

That is an important difference between SRLN and a standard junk bond ETF because SRLN holds high-yield debt. Over 35 percent of the ETF's holdings are rated BB or BB- and another 21.4 percent are rated B. SRLN holds 256 issues and has a 30-day SEC yield of 3.84 percent.

“Senior loans offer a floating rate coupon that resets every three months, a structure that has allowed senior loans to outperform traditional fixed rate high yield in rate hike cycles like the one we’re in today,” said SSgA. “In the last three rising interest rate periods, senior loans have returned an average 6.5 percent, while, as the chart below shows, high yield bonds have returned an average of just 2 percent.”