Senior Loan ETFs Yielding 6% Face New Actively Managed Rival

| About: SPDR Blackstone/GSO (SRLN)
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ETFs indexed to senior loans have been gaining traction with investors looking for above-average yields and some protection from rising interest rates. Now State Street Global Advisors is trying to muscle in with a new actively managed ETF designed to beat the index on a risk-adjusted basis, rather than simply track it.

State Street developed the active ETF along with GSO Capital Partners LP, the global credit business of private equity giant Blackstone Group (NYSE:BX).

The new SPDR Blackstone/GSO Senior Loan ETF (NYSEARCA:SRLN), which listed Thursday, will try to outperform the Markit iBoxx USD Liquid Leveraged Loan Index and the S&P/LSTA U.S. Leveraged Loan 100 Index.

SRLN has an expense ratio of 0.90%, a bit higher than the two existing passively managed ETFs that invest in senior loans.

Senior loans are private debt instruments issued by a bank and provide capital to companies that typically fall below investment-grade credit ratings. They pay higher yields to compensate investors for the extra risk. Additionally, as a floating rate instrument, senior bank loans provide some cushion from rising interest rates.

Investors have been buying senior loans after Federal Reserve chief Ben Bernanke hinted that the central bank could curb asset purchases if the economy continues to heal, reports Sridhar Natarajan for Bloomberg.

Active management

SRLN is the first actively managed ETF for senior loans.

"Given the high turnover of senior loans and the critical importance of credit selection, we believe an active strategy provides a key advantage to investors who want access to this corner of the market," said James Ross, global head of SPDR ETFs at State Street.

GSO/Blackstone Debt Funds Management LLC is the ETF's subadvisor. When picking securities for the fund, it will seek to construct a portfolio of loans it believes is less volatile than the general loan market, according to the prospectus.

Investors in the new senior loan ETF will essentially be betting that the GSO/Blackstone managers have the expertise and skill to outperform the index when volatility is factored in. State Street says the strategy is "designed to generate higher risk adjusted returns while seeking to maintain capital preservation."

A three-horse race in senior loan ETFs

The new actively managed ETF will be going head-to-head against two passive senior bank loan ETFs: PowerShares Senior Loan Portfolio (NYSEARCA:BKLN), which tracks the S&P/LSTA U.S. Leveraged Loan 100 Index; and the Highland/iBoxx Senior Loan ETF (NASDAQ:SNLN), which tracks the Markit iBoxx Liquid Leveraged Loan Index.

SNLN has a 0.55% expense ratio and a yield to maturity of 5.45%. It holds assets of $60.5 million and was launched in November 2012.

BKLN has a 0.66% expense ratio and a yield to maturity of 5.69%. The ETF is much larger with over $3 billion in assets under management. It is also one of the most popular ETFs so far this year with net inflows of $1.6 billion, according to IndexUniverse data.

The ETF's solid inflows may reflect some investors rotating away from high-yield corporate bonds and into senior loans on rising rate fears. New-issue leveraged loan volume climbed to a post-credit-crunch high of $185.2 billion in the first quarter, according to S&P Capital IQ.

BKLN is an appropriate holding for investors who are comfortable assuming greater credit risk and who may be looking for floating-rate bonds to protect against rising interest rates, says Morningstar analyst Timothy Strauts.

"Bank loans are denoted 'high yield' in large part because the firms issuing them are highly leveraged," he writes in a report on the ETF. "Most investors typically become interested in bank loans when interest rates are expected to rise."

Max Chen contributed to this article.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.