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Demand for actively managed senior loan ETFs has skyrocketed in the past year, helping State Street Global Advisors and First Trust fill their coffers. Indeed, the two firms have pulled nearly $9 billion combined into these less interest rate-sensitive, yet higher-yielding fixed income securities. However, they may soon have to compete with BlackRock, the leading provider of fixed income ETFs, based on an analysis of recently published and favorable commentary on the investment merits for the fixed income subcategory.
Bank loans are typically issued to smaller companies with below investment-grade (or junk) credit ratings. Yet, unlike high-yield corporate bonds, bank loans offer floating rates that rise along with the Fed funds rate or related benchmarks like Libor (the London interbank offered rate). This attribute has historically helped bank loans outperform broad U.S. fixed income and investment-grade bonds in periods similar to today when interest rates are rising.
Seven years ago, BlackRock CEO Larry Fink told investors that the firm will not do a bank loan ETF. Soon after, the global head of iShares at the time, Mark Wiedman, told the Wall Street Journal that the company had decided not to offer a bank loan ETF, in large part because bank loans are illiquid and a stress to the credit market could lead to a different outcome than what investors expect. Furthermore, investors could unknowingly sell their ETFs at a massive discount to their underlying value.
While that might indeed occur, recent data suggests that ETF investors are buying or selling at a fair price. The SPDR Blackstone Senior Loan ETF (SRLN ), which has $11 billion in assets thanks to $6.6 billion of net inflows in the past year, closed every day since the beginning of 2021 within 100 basis points of its net asset value (NAV). The widest gap was a discount of 80 basis points in mid-March 2022, but a mere three trading days later, the differential had turned into a slight premium.
The First Trust Senior Loan Fund (FTSL ), which pulled in $2 billion in the past year to double in size to $3.8 billion, never closed at more than a 41 basis point discount in the last 15-plus months.
While these are currently favorable times for senior loan ETFs, as BlackRock now explains, the market is different than it used to be. James Keenan, CIO and global head of credit, and Carly Wison, portfolio manager for bank loans and global long/short credit strategies, write that the annual secondary trading volume of bank loans grew by roughly one-third over the past five years and hit a record $780 billion in 2021.
Keenan and Wilson further believe that high turnover of bank loans affords ETF managers, and others, more opportunities to move in and out of positions efficiently.
With BlackRock’s views on senior loans having evolved in response to the bond market, we expect that the firm will soon launch a related ETF product. While many of the firm’s largest fixed income ETFs track an index, like the iShares Core Aggregate Bond Index (AGG ) and the iShares $iBoxx High Yield Corporate Bond ETF (HYG ), the trend has been moving toward actively managed senior loan ETFs.
Indeed, while FTSL and SRLN have been raking in the cash in the past year, the index-based Invesco Senior Loan ETF (BKLN ) has seen nearly $700 million of net outflows.
Meanwhile, FTSL and SRLN rose 2.2% and 2.0%, respectively in the past year, ahead of the 0.80% gain for BKLN, highlighting that active management can add value in this fixed income sub-category.
Indeed, Keenan and Wilson argue that actively managed strategies in the bank loan market can provide investors with both the skill of navigating risks in all market and liquidity conditions and the potential advantage of security selection.
Start the clock on when BlackRock has an active senior loan ETF trading under the ticker ISLN or something similar.
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