State Street Launches Senior Loan ETF - ETF News And Commentary

Product development in the ETF world is surging ahead to start April, with State Street being the latest company to debut a new fund. Its latest product, the SPDR Blackstone/GSO Senior Loan ETF (SRLN), looks to give investors a new, active option in the increasingly popular senior loan market.

This continues the trend of new options in the fixed income slice of the market, and especially in the short end of the curve. Despite bond bubble worries, this corner of the bond market remains extremely popular so it isn’t too surprising that State Street is throwing its hat into the ring in this segment.

What is a senior loan?

Senior loans have become pretty popular in the last few months in the fixed income world, largely thanks to their low interest rate risk. Senior loans usually have rates set a specific level above LIBOR and these reset every three months, so big bond market moves shouldn't be an issue (also see the Comprehensive Guide to Money Market ETFs).

This should help to virtually eliminate interest rate risk, a key selling point if bond rates rise. Furthermore, since these securities are ‘senior’ investors in these notes have priority in a credit event, so default risk is low in these bonds, although these senior loans are usually issued on higher risk companies.

Senior Loan ETF in Focus

The new ETF looks to provide investors with current income, along with the preservation of capital. It will not track an index though, seeking instead to beat out the Markit iBoxx U.S. Leveraged Loan 100 Index through superior security selection.

This looks to be done by partaking in credit analysis, and timely sales and buys of senior loans. For example, the active approach looks to acquire loans at attractive prices before they are added to an index, or find loans that are likely to be removed from a benchmark and then proactively sell them before they are kicked out of an index.

Overall, the fund looks to charge 90 basis points a year in fees, while paying out distributions on a monthly basis. The portfolio is pretty spread out at first glance, as bonds from Chrysler, Alcatel Lucent, and AES take the top three spots but only account for about 3.38% each.

How does it fit in a portfolio?

This ETF could be a decent choice for investors seeking fixed income exposure, but without the interest rate risk. This could be vital if bond rates rise, as longer-dated products would get crushed in this type of environment (see Buy These Bond ETFs for Income and Diversification).

It could also be appropriate for those who believe in the benefits of active management, and particularly in the less-liquid fixed income space where pricing issues may develop. However, this also does increase the cost of the product, so it may not be a top pick for investors seeking a rock-bottom choice from an expense perspective.

Investors should also note that, due to the lack of risks, yields might not be that big for this fund. LIBOR is below 0.30% for the 3 month version, so investors will need a modest spread over this rate in order to generate yield.

This is certainly possible, as senior loans are often issued by companies that are junk rated. Due to this, rates on their senior loans, while yielding less than their 'regular' counterparts, should at least be decent when compared with other options in the market.

Can it succeed?

Unfortunately for State Street, there is already some serious senior loan ETF competition on the market. There are two solid funds with decent AUM already, including the Highland iBoxx Senior Loan ETF (SNLN) and the PowerShares Senior Loan ETF (BKLN).

BKLN has seen an amazing surge in popularity so far in 2013, as the fund has amassed more than $1.5 billion since the beginning of January. This is more than half of its total assets under management, so clearly interest in the asset class is starting to pick up (see Should You Buy The Senior Loan ETF?).

This is also evidenced by SNLN’s decent level of accumulation since its debut in November of 2012. Since then, the fund has added about $60 million in assets, a pretty respectable figure, and especially so for an upstart like Highland.

While these solid asset levels may be somewhat troubling to State Street and their new fund launch, it also does suggest that there is an incredible level of interest in the space. This could make SRLN have a better launch than what some might be expecting given the competition level (read Pyxis Debuts Senior Loan ETF).

The real key will be if the fund can deliver with its outperformance thanks to active management. If this is the case, SRLN could see a decent amount of inflows and capture at least a fraction of the interest in this increasingly in-focus corner of the bond world.

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