Senior Bank Loans: High-Yield With Perks

By ETFDatabase | October 25, 2012 AAA

With interest rates stuck at all-time lows, and expected to remain there for some time, investors of all walks have been eager to beef up their portfolio's current income. Luckily, the ETF universe is vast and investors have handfuls of options when it comes to generating yield; within the fixed-income market, one asset class in particular has managed to fly under the radar for most, although it warrants a closer look from anyone looking to tame overall volatility without sacrificing yield.

With ETFs opening up the doors to the global fixed-income market to mainstream investors, many have been quick to flock to well-known segments of the high-yield universe; junk bonds from U.S. and foreign issuers have garnered tremendous interest as this asset class has demonstrated the potential to deliver attractive distributions without taking on exorbitant risk. As such, it's not terribly surprising to see that the two biggest funds in the High Yield Bonds ETFdb Category focus on below investment-grade corporate debt.

The bigger of the two is the iShares iBoxx High Yield Corporate Bond Fund , which boasts over $17 billion in assets under management, while its competitor, the SPDR Barclays Capital High Yield Bond ETF trails behind with a portfolio totaling over $12 billion, showcasing the sheer interest in this lucrative space. The third most popular ETF in this category, however, is the only one of its kind to focus on a particularly attractive, and often overlooked, breed of debt notes: enter the PowerShares Senior Loan Portfolio .

Why You Need A Senior Bank Loan ETF

Bank loans have been flying under the radar for many fixed-income investors as ETFs have only recently opened up the doors to this asset class. Senior bank loans share a lot of common traits with regular junk bonds, however, a closer look at their differences reveals noteworthy insights.

First and foremost, senior bank loans are privately arranged debt instruments issued by a bank that provides capital to a company usually with a below investment-grade credit rating. Where these securities differ from junk bonds is in their underlying structure; although both of these high-yield corporate debt notes are rated below investment-grade, senior bank loans generally carry less risk than their traditional junk bond counterparts as they are secured by collateral in the event of a default. By nature, these loans are considered senior to all other claims against the borrower, which means that in the unlikely event of bankruptcy the senior bank loan is the first to be repaid ahead of other debt obligations .

In addition to boasting a safer risk profile, senior bank loans are also more favorably positioned over the long-term because they are floating rate instruments. Although interest rates are at historically low levels now, there is no doubt that the Fed will eventually raise rates to curb inflation. In the event of an interest rate hike, fixed-rate bonds of all sorts, including those found in HYG and JNK, would suffer far more than floating rate securities; the ability to keep pace with interest-rate changes effectively makes senior bank loans more stable than typical bond funds for buy-and-hold investors of the long-haul.

Inside BKLN's Portfolio

The PowerShares Senior Loan Portfolio offers exposure to an attractive corner of the junk bond space that has largely been overlooked. Because these debt notes arefloatingrate and secured by collateral, it's nosurprisethey offer a bit less in the way of yield compared to offerings like HYG; when comparing recent 30-day SEC yields, we see that BKLN boasts a 4.89% distribution, versus the more popular HYG which features a 5.48% distribution. The smaller dividend payout is, however, fairly compensated as BKLN's underlying holdings are effectively secured, floating rate, high-yield debt notes while virtually all other competitors in the space offer exposure to unsecured, fixed-rate, high-yield debt .

As the only ETF targeting this segment of the high-yield bond market, BKLN has managed to accumulate an impressive $1 billion in assets under management since launching fairly recently in early 2011. Digging deeper, we see that this fund features a well-balanced portfolio; BKLN is comprised of nearly 140 securities in total and it allocates less than one-fifth of total assets to its top ten holdings. From a cost perspective, BKLN is not the cheapest in the space, although its above-average 0.76% expense ratio is certainly well worth the few extra basis points considering that it's the only one of its kind .

Investors looking beef up their portfolio's yield while simultaneously diversifying their fixedincomecomponent ought to take a closer look at the PowerShares BKLN ETF as it stands to offer a truly compelling strategy that many stand to benefit from.

Follow me on Twitter@SBojinov

Disclosure: No positions at time of writing.

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