Should You Buy The Senior Loan ETF? (BKLN, JNK)

Eric Dutram: Although many investors shy away from bond ETFs in this low rate environment, there are still a number of quality choices in the fixed income ETF world. These products can help investors to reduce dependence on equities while providing a nice regular payment far above what most stocks can deliver at this time.

This is especially true if investors are willing to venture outside of the investment grade market and into junk securities instead. While these bonds are riskier, they give investors outsized payouts which can help to greatly increase current income for any portfolio (see Is The Bear Market For Bond ETFs Finally Here?).

In the junk bond space, there is an often overlooked slice of the market that could be an interesting choice for those with minimal levels of exposure to the market. This corner is what is known as senior loans or ‘leveraged loan’ market, a specific corner of the below investment grade world.

These notes are, generally speaking, floating rate bonds which see rates adjust on a monthly or quarterly basis. However, they are often made by companies that are already heavily in debt suggesting big risks. Nevertheless, these senior loans are, as you might expect, ‘senior’ to other types of debt and are among the first to be paid out in a liquidity event.

Given the interest rate resetting feature and the low credit quality of the bonds in this segment, these loans can provide investors with both a hedge against rising interest rates but also higher levels of income than other types of floating rate securities (read Do You Need A Floating Rate Bond ETF?).

Thanks to this, senior loans could be a nice mix between high income and lower interest rate sensitivity making them ideal investments for many investors.

Unfortunately, the senior loan market is still pretty small and thus somewhat difficult for investors to buy into. However, there is one dedicated ETF that is currently tracking the space the PowerShares Senior Loan Portfolio (NYSEARCA:BKLN).

This relatively new bond ETF is currently the only way investors have to play the senior loan market via the ETF structure. The product tracks the S&P/LSTA U.S. Leveraged Loan 100 Index which looks to act as a benchmark for the largest institutional leveraged loans based on market weightings, spreads, and interest payments (see more on ETFs at the Zacks ETF Center).

Currently, the ETF holds about 120 securities in total with the vast majority maturing in between one and ten years. With this approach, the fund has a SEC 30 Day Yield of about 4.8% while interest rate risk is minimal; the average days to reset is just over 33.5.

However, investors should note that the product is relatively expensive when compared to other ETFs focused on the low end of the debt market. The current expense ratio is 76 basis points a year, triple some of the low cost junk bond ETFs.

Fortunately, the AUM is high at about $415 million, promoting high levels of interest from traders. In fact, volume is generally at 160,000 shares per day, giving the fund an extremely low bid ask spread (also read ETF Investors: Beware The Coming ETN Backlash).

Yet the real test for this product is when investors put it up against one of the more popular junk bond ETFs on the market today, the SPDR Barclays High Yield Bond ETF (NYSEARCA:JNK).

In terms of yield, JNK crushes its counterpart, paying out over 200 basis points more a year in income. Additionally, from a performance perspective, JNK has easily beaten out its counterpart over the past year:

With that being said, investors should note from the chart above that JNK has been far more volatile than its bank loan counterpart, experiencing greater moves in short time periods. Thanks to this volatility, as well as the higher interest rate risk in JNK, some investors might still want to consider BKLN for their exposure (seeTop Three High Yield Junk Bond ETFs).

That is because BKLN looks to a lower risk choice in the space while still providing high income levels than many investment grade products. So if investors are willing to forgo a little in income and pay more in fees, BKLN could be an interesting choice for some investors.

While it has trailed some of its counterparts in the past, the product looks well poised to take advantage of a rising interest rate environment in the future, especially when compared to its peers in the junk bond ETF space.

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Written By Eric Dutram From Zacks Investment Research

In 1978, Len Zacks discovered the power of earnings estimates revisions to enable profitable investment decisions. Today, that discovery is still the heart of the Zacks Rank, a peerless stock rating system whose Strong Buy recommendation has an average return of 26% per year.

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