Depressed interest rates are prompting advisors and investors to embrace income-generating assets beyond the safest bonds. The Invesco Senior Loan ETF (BKLN ) is one noteworthy option.
BKLN targets the S&P/LSTA U.S. Leveraged Loan 100 Index. That index “is designed to track the market-weighted performance of the largest institutional leveraged loans based on market weightings, spreads and interest payments,” according to Invesco.
Leveraged loans usually attract investors who are looking to generate income in a rising interest rate environment due to their floating rate component. However, central banks and agencies like the International Monetary Fund warn that credit quality is declining – bank loans are usual for highly leveraged companies and are rated speculative-grade.
“Income investors have been moving back into this sector in their quest for high yields, as bonds offer little return but significant risk. Loan mutual funds saw their biggest three-week inflows since 2017, totaling some $2.5 billion, according to a Jan. 29 Bank of America research note,” reports Randall Forsyth for Barron’s.
Back BKLN for Bank Loan Exposure
Since rates are typically reset once per quarter, senior loans typically have low durations – a measure of a bond fund’s sensitivity to changes in interest rates. The floating-rate component also offer investors an alternative method of earning yields while mitigating interest-rate risk. Consequently, bank loans are seen as an attractive substitute to traditional corporate debt in a rising rate environment.
In other words, some investors may not feel compelled to avoid interest rate risk at a time when rates are declining. However, there are still reasons to consider BKLN, even as rates are falling.
“Loans are senior to bonds in corporate capital structure and thus get paid first. Most loans also have floating interest rates, usually tied to a short-term benchmark such as the 90-day London interbank offered rate, or Libor,” according to Barron’s.
Senior loans are typically used for business recapitalizations, acquisitions, leveraged buyouts, and re-financings. BKLN’s loan portfolio will include the purchase of loans from banks or other financial institutions through assignments or participations.
Additionally, BKLN may acquire a direct interest in a senior loan from the agent or another lender via an assignment or an indirect interest in the loan by participating in another lender’s portion of a loan. BKLN sells the loans within the portfolio through an assignment, but it may also sell participation interests in the loans in order to fund redemption requests.
The inherent risks associated with senior loans are similar to the risks of junk bonds, but have seniority in the event of borrower default. If the business is forced to sell its assets in a liquidation scenario, the senior loan will be paid first. In addition, senior loans are secured by assets whereas junk bonds are not, making them a more attractive investment option when constructing a loan portfolio.
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