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The so-called “Great Rotation”--from bonds to stocks--appears to be taking longer than earlier expected. While there were increased inflows into equity funds earlier this year, the trend slowed down later on account of renewed worries about global growth and troubles in the Euro-zone.
Though ETF investors showed a clear preference for equity funds, most mutual fund investors continued to put money in bond funds as well. Additionally, most of the money going into stocks came from the cash lying on the sidelines. (Read: 3 Excellent ETFs for Income Investors)
However, it was clear that investors were getting increasingly worried about the interest rate risk in their bond portfolios. ETF flows during the first quarter show that more interest rate sensitive ETFs like iShares iBoxx $ Investment Grade Corporate Bond Fund (LQD - ETF report) and iShares iBoxx $ High Yield Corporate Bond Fund (HYG - ETF report) lost money, and funds with less interest rate sensitivity/shorter duration gathered assets.
Recent FOMC minutes revealed that there is a growing debate within the committee about continuation of asset purchases at current levels. Once the Fed slows down its purchases, interest rates will start to rise. In fact, the ten-year note did break the psychological barrier of 2% earlier this year but the yields declined later. Within the fixed income space, junk bonds appear to be at highest risk.
Investors looking for higher yields but concerned about the potential rise in interest rates should look at Senior Loan ETFs. (Read: 3 REIT ETFs you should not ignore)
Senior loans are secured by company’s assets and are thus lower in risk structure, even though these loans are mostly issued by companies with below investment grade credit. These are floating rate loans so they usually pay a spread over some benchmark rate like LIBOR. Thus, in the event of rise in interest rates, coupons on senior loans increase while the value of the investment remains stable. On the other hand, bonds lose value if the interest rates go up.
So, investors in senior loans or in senior loans ETFs get the benefit of high yields with protection against any interest rate rise. Further, they carry lower credit risk compared with most other assets with similar level of yield. Additionally senior loans have low correlations with other asset classes. (Read: 3 High Yield ETFs for your IRA)
PowerShares Senior Loan Portfolio (BKLN - ETF report)
BKLN is based on the S&P/LSTA U.S. Leveraged Loan 100 Index which is designed to track the largest institutional leveraged loans based on market weightings, spreads, and interest payments.
The ETF currently holds about 131 securities in total. With most of these holdings maturing between one and ten years, the fund has years to maturity at 5.18. In terms of credit rating, about 42% of the holdings are “BB” while 44% are ranked "B" by S&P.
The product is slightly expensive with an expense ratio of 66 basis points a year, but it pays out an attractive dividend yield of 4.74% at present.
The ETF was launched in March 2011 and has managed to attract about $3.7 billion in assets, of which $2.1 billion came this year—making it the second highest asset gatherer among fixed income ETFs year-to-date.
The volume is generally high at around 870,000 shares per day, giving the fund an extremely low bid ask spread.
Pyxis/iBoxx Senior Loan ETF (SNLN - ETF report)
The product follows the Markit iBoxx Liquid Leveraged Loan Index and is the lowest cost choice in the space, charging 55 basis points in annual expenses. The ETF was launched in November last year and currently has $60.5 million in AUM. It’s holdings have a weighted average maturity of 4.83 years.
SPDR Blackstone / GSO Senior Loan ETF (SRLN - ETF report)
SRLN is the actively managed product in the space. It seeks to outperform both the Markit iBoxx USD Liquid Leveraged Loan Index and the S&P/LSTA U.S. Leveraged Loan 100 Index. The ETF was launched earlier this month and has so far collected $152.6 million in assets.
The product currently holds 92 securities and charges 90 basis points in expenses.
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