High-Yield Senior Loan ETFs

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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 ETFs 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 its competition?

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 long-horizon investors.

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 sbogart@indexuniverse.com.


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This article appears in: Investing , ETFs

Referenced Stocks: BKLN , FLOT , FLTR , HYG , JNK

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