While the high-yield ETF space is certainly crowded, the
Pyxis/iBoxx Senior Loan ETF (NYSEArca:SNLN) offers an
unconventional twist to the high-yield space:It tracks an index of
senior loans as opposed to conventional junk bonds.
The mutual fund company's foray into the world of
was supposed to take place today-Tuesday, Oct. 30-but Hurricane
Sandy delayed its launch. The rollout is likely to take place later
this week or early next week.
So what's the investment case for SNLN? Is this just another
"me-too" product grasping for yield, hoping to tap into the same
mother lode of investor enthusiasm that the $1.2 billion
PowerShares Senior Loan Portfolio (NYSEArca:BKLN) quickly got a
piece of after it launched in March 2011?
Aside from potential returns, the strength of a fund like SNLN
is that it may offer protection against rising interest rates. It
tracks an iBoxx index of senior loans, which are floating-rate
securities. This means that coupon payments reset according to
prevailing interest rates. That, in turn, reduces duration and
interest-rate risk of the fund.
As a result of its reduced interest rate risk, SNLN is likely to
outperform portfolios of comparable junk bonds in a rising interest
rate environment, though it's also likely to underperform when
interest rates are declining.
Senior loans are alluring because they offer yield in a world
nearly devoid of it.
Senior loans can offer substantial yield advantages over
investment-grade securities because they're usually issued to
riskier companies that must compensate investors for risking their
own capital on loans with the company.
Senior loans are also attractive because they're relatively less
volatile than other high-yield or fixed-rate instruments.
This is primarily because of the floating-rate aspect of senior
loans, which means that changes in prevailing interest rates tend
to have a much more modest impact on the price of a senior loan
than on comparable fixed-rate securities.
Often, senior loans are issued with a company's assets as
collateral; this serves to reduce risk of loss in case of default
and also reduces volatility.
Another advantage of senior loans is that, much like high-yield
bonds, they have little correlation to Treasurys, emerging-market
bonds, investment-grade securities and equities. Thus, a senior
loan ETF can be a great way to diversify a portfolio.
So, how does SNLN fit into the space and how does it stack up to
SNLN is going head-to-head with the PowerShares Senior Loan
Portfolio ETF (NYSEArca:BKLN). BKLN was first on the market and has
proved to be a hit:The fund has amassed over $1 billion in assets.
It's safe to assume the two portfolios will be very similar,
although we won't know definitively until SNLN launches.
We do know that SNLN will hold fewer securities:BKLN currently
holds 135 securities, whereas SNLN will sample from an underlying
index of 100 securities. The other difference we can point out now
is that BKLN charges 0.76 percent a year, while SNLN's planned
annual expense ratio will be 0.55 percent.
But unless SNLN comes out of the gate blazing, its trading costs
in the form of relatively wide bid/ask spreads are likely to trump
any advantage from its lower expense ratio. That said, SNLN's
expense ratio could provide it a substantial advantage for
BKLN aside, the ETF space is riddled with funds that pursue
floating-rate strategies, including the $357 million iShares
Floating Rate Note Index Fund (NYSEArca:FLOT), and the Market
Vectors Investment Grade Floating Rate ETF (NYSEArca:FLTR), which
has gathered just over$7 million in assets.
Additionally, high-yield strategies such as the $17 billion
iShares iBoxx $ High Yield Corporate Bond Fund (NYSEArca:HYG) and
the $12 billion SPDR Barclays Capital High Yield Bond ETF
(NYSEArca:JNK) have proven immensely popular as well, since
official interest rates were cut to near zero in the aftermath of
the 2008 financial crisis.
SNLN's and BKLN's senior loan strategies can be considered a
hybrid of the floating-rate strategy and high-yield strategy.
Floating-rate funds pursue investment-grade securities, while the
high-yield funds generally only invest in fixed-rate bonds.
The senior loan approach may be the goldilocks between the two
strategies:It goes for the higher-yielding, subinvestment-grade
companies issuing floating-rate securities.
Ultimately, whether it's BKLN or SNLN, senior loan ETFs are
worth a closer look because they have interesting attributes.
Those include low correlation to other asset classes, lower
volatility than comparable high-yield bond portfolios, higher yield
than floating-rate note portfolios and potential protection against
rising interest rates.
And what's not to like about that?
At the time this article was written, the author had no
positions in the securities mentioned. Contact Spencer Bogart at
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