High-Yield Senior Loan ETFs
October 30, 2012
This week a new issuer is likely to come out of the woodwork to offer another take on the ultra-popular theme of the year—high-yield ETFs.
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?