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Why Bank Loan ETFs Offer Yield Opportunity

Gary Stringer

This article is part of a regular series of thought leadership pieces from some of the more influential ETF strategists in the money management industry. Today’s article features Gary Stringer, president and chief investment officer of Memphis, Tennessee-based Stringer Asser Management.

We think bank loan ETFs offer an attractive risk/reward profile in this challenging fixed-income environment.

Spreads in most credit sectors have recently tightened to levels below their long-term averages, making it harder for investors to get paid for the level and types of risks they are exposed to.

While all spread sectors are relatively expensive compared with their long-term averages, bank loans have not rallied as strongly as other high-yield bonds, making them an interesting option in the high-yield space.

Floating Coupons

Additionally, bank loans are issued with floating coupons, making them favorable in an environment where short-term rates are likely to increase. With rising short-term rates, strong demand and relative value within the high yield-arena, bank loans offer an attractive risk/reward profile, in our opinion.

Bank loans have also benefited from a strengthening economy and credit outlook, as well as potential continued growth from fiscal stimulus. Job creation remains healthy, and the unemployment rate continues to fall, with the economy at full employment.

 

Yield Opportunity

In terms of price, bank loans have not experienced the same degree of overvaluation as longer-duration fixed-rate high-yield bonds, which have experienced a more dramatic drop in yield. A lot of their attractiveness can be attributed to the fact that there is some price compression as bank loan refinancing picks up when short-term rates are rising. This creates a yield opportunity in an environment of strong credit markets and low default rates.

While we do not expect to see a large degree of price appreciation going forward due to refinancing activity picking up, we do find the sector’s yield relatively attractive compared to its risks.

Regarding risk, rising short-term rates and strong demand should provide price support for the bank loan sector. As rates rise, the coupon on a bank loan is reset to keep up with the prevailing market rates. This can help limit the downside risks associated with rising interest rates, thus providing some price support not found in other fixed-rate securities.

Furthermore, we see technical support for the sector, as demand for higher-yielding fixed-income sectors remain strong and will likely continue to see interest in a stable economic backdrop. At the same time, new issuance has declined, which creates a supportive environment, especially for older loans with higher reset spreads.

There are many RTF options available for investors looking to add dedicated exposure to the bank loan space. Some of the most liquid funds include the SPDR Blackstone / GSO Senior Loan ETF (SRLN), the PowerShares Senior Loan Portfolio (BKLN) and the First Trust Senior Loan ETF (FTSL).

At the time of writing, Stringer Asset Management held BKLN among its universe of ETFs included in its suite of ETF Portfolios. SAM is a Memphis, Tennessee third-party investment manager and ETF strategist. Contact SAM at 901-800-2956 or at info@stringeram.com. For a complete list of relevant disclosures, please click here.

 

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