Asset managers eye loan ETFs as interest rates rise  

NEW YORK, April 4 (LPC) - Asset managers including Franklin Templeton Investments and O’Shares Investments are getting ready to launch new bank loan exchange-traded funds (ETFs) to benefit from a rising interest rate environment.

The US$13bn bank loan ETF market has attracted around US$437m of new money in 2018 as more existing managers launch new funds, according to Morningstar data and Securities and Exchange Commission (SEC) filings.

Loan ETFs give exposure to floating-rate senior loans, which are difficult for retail investors to access and trade, and are often used as a hedge against rising interest rates, as loan coupons increase.

“Investors have been more interested in bank loans with interest rates slowly rising,” said Chris Romano, director of research at ETF Global.

ETF funds are becoming more attractive to yield-hungry investors, who face diminishing returns from fixed income securities in a higher rate environment.

“I expect more demand for bank loans and any kind of adjustable-rate product that can increase its yields and take advantage of the higher rates,” Romano said.

Loan ETFs and mutual funds took in US$331.6m in the week ending March 28, which was the sixth straight week of inflows, according to Lipper U.S. Fund Flows data. Investors added US$322m to loan ETFs in March, the biggest monthly inflows since October 2017, the data shows.

POWER DUO

Six loan ETFs are currently traded on the New York stock exchange and Nasdaq. The two biggest are the US$2.8bn SPDR Blackstone/GSO Senior Loan ETF (SRLN) and the US$8bn PowerShares Senior Loan ETF (BKLN), which have seen about US$154m and $150m of retail inflows in 2018, respectively.

The two ETFs have different strategies - SRLN is actively managed by portfolio managers who select and oversee the 282 U.S. and non-U.S. leveraged loans, while BKLN tracks an index of the 100 largest U.S. senior loan facilities.

Careful credit selection is crucial in the loan space, to avoid low liquidity and defaults, said Matthew Bartolini, head of SPDR Americas research at State Street Global Advisors.

“Because SRLN is actively managed, you don’t have to hold something just because it’s in an index of hundreds of loans,” said Bartolini.

Active management can help to avoid credit blowups like Toys R Us, which went into Chapter 11 bankruptcy protection in September 2017 and iHeartMedia, which filed for Chapter 11 in March and is rated D by Standard & Poor’s.

“The two glaring cases right now of why active management is positive in the loan space are SRLN does not hold any Toys R Us credit nor iHeartMedia,” Bartolini said.

BKLN’s underlying index holds IHeartMedia’s parent iHeartCommunications’ term loan due December 2019 with a 9% coupon rate.

BKLN returned 2.4% in 2017 while SRLN returned 3.6%, according to Morningstar data. They both posted a 1.2% year-to-date return. BKLN has an expense ratio of 65bp and SRLN costs 70bp. The asset-weighted average ETF fees were 24bp in 2016, according to Morningstar data.

BKLN, which was the first-ever bank loan ETF, has had first mover advantage since its launch in 2011, and has the benefit of liquidity and intra-day dealing due to its size, said Scott Baskind, head of global senior loans at Invesco.

“The makeup of BKLN is the hundred largest issues in the market. It’s a higher quality pool than the broad market,” he said.

NEWCOMERS

The most recent bank loan ETF was Amplify YieldShares Senior Loan and Income ETF (YESR) which was launched in August 2017 and employs a fund of funds structure. YESR has US$3.7m of assets under management.

YESR invests in 24 senior loan closed-end funds which use leverage and offer value and higher income as they trade at a discount to net asset value, said Christian Magoon, chief executive officer of Amplify ETFs.

Although more managers are gearing up to enter the loan ETF space, it is harder to be a late entrant unless fees are aggressively low, said Todd Rosenbluth, senior director of ETF and mutual fund research at CFRA.

“Franklin Templeton is planning to go active. There’s a number of asset managers that have entered the ETF marketplace that have a strong active management presence, so I think that it’s an area that could see more ETFs. The fixed income ETF market is still in the earlier stages,” Rosenbluth said.

A spokesperson at Franklin Templeton declined to comment. O’Shares Investments confirmed the SEC filing. (Reporting by Yun Li Editing by Michelle Sierra and Tessa Walsh)