Right Place, Right Time For This Fixed Income ETF

The Federal Reserve unveiled its first interest rate hike of 2017 and third in 15 months earlier this week. Now, bond market participants appear comfortable betting the Fed is heading toward another two rate increases before 2017 ends, a scenario that predictably has some investors reviewing the bond portions of their portfolios.

Simply because rates are rising doesn't mean all fixed income investments will be punished. In fact, exchange traded funds have increased accessibility to corners of the bond market that can prove durable in the face of a more hawkish fed. That includes senior loans or bank loans, which can be accessed via several active and passive ETFs.

The SPDR Blackstone/GSO Senior Loan ETF SRLN is a compelling idea for investors looking for active management with 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.

“In previous tightening cycles, senior loans have demonstrated their benefit,” State Street Global Advisors (SSgA) said in a recent note. “Senior loans have returned an average 6.5% in the last three rising rate periods, while high yield bonds have returned an average of just 2%.”

Due to the floating rate element, duration isn't as important to an ETF like SRLN as it is with traditional bond funds. The current three-month LIBOR on SRLN is just 1.15 percent and the average maturity for the ETF's 254 holdings is just under 5.4 years. SRLN holds 31 senior loans issued by technology and healthcare companies, a group combining for 26.6 percent of the ETF's weight.

“Senior loans may have added benefits during this normalization cycle versus traditional fixed rate high yield, as oil price swings trigger fears of an up-tick in high yield defaults,” said SSgA. “By sitting higher in the capital structure than high yield and typically offering a floating rate structure that resets every three months, senior loans may be able to navigate rising rates and mitigate some of the downside risks in credit markets without limiting income generation potential.”

SRLN has a 30-day SEC yield of 1.6 percent and over $1.4 billion in assets under management.