Last week (3/3/11) brought the debut of PowerShares Senior Loan Portfolio (NYSEARCA:BKLN). This is the first ETF to offer exposure to senior bank loans, though several mutual funds already cover the niche with what are often called “floating rate” funds. The launch is well-timed as inflation fears drain assets from other types of fixed-income ETFs.
What are “senior loans” and what gives them seniority? Also known as “syndicated loans” or “leveraged loans,” these are debt instruments that represent loans made by banks to companies with a credit rating below investment grade. The “senior” part means that they are ranked higher than the borrower’s other debts and are therefore slightly less risky. They may also be secured by collateral.
What makes senior loans different from junk bonds is that they are floating rate debt – similar to a variable rate mortgage. The interest rate is usually a defined percentage above a reference benchmark like LIBOR and is reset monthly or quarterly. This greatly reduces exposure to the risk of rising interest rates. It does not completely remove that risk, however: the higher rates could always force a borrower into default.
Senior loans therefore offer more “credit risk” and less “interest rate risk” than Treasury bonds. Their low correlation to other bond sectors can make them a useful diversification tool for a fixed-income portfolio. The higher yields don’t hurt, either. BKLN came out into a market where income investors are searching for both yield and inflation protection. Volume was heavy from the first day of trading, so it looks like PowerShares scored with this one.
BKLN will track the S&P/LSTA Leveraged Loan 100 Index, a market value-weighted index designed to measure the performance of the U.S. leveraged loan market. The net expense ratio is 0.83%, less than many of the senior loan mutual funds. As of 3/4/11, the yield to maturity of the portfolio’s 87 holdings was 4.9%. More information including the overview page, investor guide (pdf), and prospectus (pdf) can be found on the PowerShares web site.
Disclosure covering writer, editor, and publisher: No positions in any of the securities mentioned. No positions in any of the companies or ETF sponsors mentioned. No income, revenue, or other compensation (either directly or indirectly) received from, or on behalf of, any of the companies or ETF sponsors mentioned.