"Nothing screams shadow banking quite like a leveraged loan ETF," writes the FT's Tracey Alloway about a particularly hot corner of the ETF universe. Leveraged (also called bank or senior) loan ETFs are a hot item thanks to the protection they offer against higher rates. The PowerShares Senior Loan Portfolio (BKLN) is one of the year's best-selling ETFs.
The loans backing the ETF however, only trade "on assignment," meaning the fund is literally a lender - as BKLN's prospectus makes clear. This means funds can't exchange ETF shares for a basket of the underlying - instead they can only exchange for cash, leaving the funds exposed to any cash redemption issues.
Barclays' Brad Rogoff notes unusually large cash balance in the funds as they prepare for this rainy-day possibility. "Such large cash balances ... will naturally cause some drag on an asset class with already-limited upside."