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Michael Spacey
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This is a pseudonym. Started my career in structured finance, moved into corporate debt, and now equities. My investment style is focus on the fundamentals and figure out what the company is worth. Writing is a way for me to gather feedback and information, rather than convincing someone else to... More
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The Cleanup Call
  • (Unvetted Idea:) Arb With Bank Loans ETFs 0 comments
    Jun 6, 2014 1:51 AM | about stocks: BKLN, SRLN, SNLN, FTSL, AFT, FCT, BSL, BGB

    Over time I accumulated a long list of ideas I may never get around to - for various reasons that have nothing to do with the merit of the idea itself (perhaps its outside of my expertise, personally don't find the sectors interesting, already have similar exposures...etc)

    In particular, one group of ideas are usually at the bottom of the list - I'm just not much of a macro guy. They do make for interesting conversations though. I thought up this one b/c I (unfortunately) have one of these funds..

    Long Leveraged funds (AFT/FCT/BSL/BGB). Short Unleveraged funds (BKLN/SRLN/SNLN/FTSL)

    • The facts:
      • Unlevered loan funds (BKLN, SRLN, SNLN, FTSL) 5-20bps below NAV . No leverage. Div Yld 3.5-4%
      • LEVERAGED bank loan ETFs. (AFT/FCT/BSL/BGB): These trade at 6-8% below NAV. Avg leverage about 30-45%. Div yld 6-7%.
      • The difference in NAV discounts between the 2 groups does not make sense given the level of leverage differential!
    • Hypothesis:
      • Discount to NAV, aside from liquidity, reflects expected future loss in NAV. FCT for example has 30% leverage, so 1% loss in the underlying loans would hit NAV by 1.3%.
      • The unlevered funds discount to NAV implies 15-20bps of expected loss, so that should translate to <50bps of discount on the leveraged fund group right? But the latter are trading 6-8% below NAV.
    • Trades: One can simply buy the leveraged group. BGB for example trade with 8% discount to NAV. But what if credit losses actually hit that level?
      1. Credit neutral strategy. Buy $1 of levered funds, and short $1.3-$1.5 of unlevered.. So that the NAV on both long & short leg offsets when underlying loan prices decline by 1%. The yield give up on the short leg would be like 4%x 1.3 = 5.2%. You get a couple point of dividend carry while waiting for the market to make sense.
      2. Net short credit - short even more unlevered ETF . So that net divided = 0.
    • Potential problems. levered fund could have liquidity issues? But forced sell would force everyone to mark to market anyways. . So the unlevered fund would still be hit.
    • Obviously the market doesn't think this way. In a panic people will sell the leveraged ETFs more. But if one has the liquidity to ignore market movements, then the NAV gap should eventually correct itself.

    There has to be some other catch that I'm missing!?

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