Never ask for small loans. – Aristotle Onassis
Last week may have been a game-changer. The Fed basically saying that a “soft landing” isn’t their base case suggests that they may actually want a credit event to break inflation meaningfully through some form of a deflationary shock. Combined with other intermarket dynamics, I think we may have started entering a credit event as I keep noting in my writings. This should, oddly enough, excite investors. Why? Because if I’m right, credit spreads widen, overreact, and at some point then become too attractive to pass up when it comes to yield in corporate loans.
To that end, that’s why the Invesco Senior Loan ETF (BKLN) is worth keeping on a watchlist. BKLN is an investment vehicle designed to track the performance of the Morningstar LSTA US Leveraged Loan 100 Index. This index reflects the market-value-weighted performance of the largest institutional leveraged loans in the U.S. market, which are primarily senior secured, U.S. dollar-denominated debts with a minimum initial term of one year and a minimum par value of $50 million. The fund invests 80% of its total assets in the component securities that constitute the index. With its bi-annual rebalancing and reconstitution, the fund adheres to a “sampling” methodology to mirror the underlying index’s performance.
Key Features of the Invesco Senior Loan ETF
Investors are drawn to BKLN for its compelling yield and portfolio positioning. The fund’s 30-day SEC yield, as of September 22, 2023, stands at an impressive 8.38%. This high yield is primarily due to the fund’s investment in senior secured loans, which usually offer higher interest rates than traditional bonds due to the increased risk associated with lending to companies with lower credit ratings.
invesco.com
Another noteworthy feature of the fund is its positioning. Senior loans, being collateralized and having a higher claim on a company’s assets, offer a degree of protection during market downturns. Furthermore, as senior loans are floating-rate instruments, they may fare better during periods of rising interest rates, making them an attractive option for investors seeking to shield their portfolios from interest rate risk.
Analyzing the Fund’s Performance
BKLN’s performance is noteworthy when compared to other asset classes. For instance, the Bloomberg US Aggregate Bond Index (AGG), a broad measure of the U.S. investment-grade fixed-rate bond market, has underperformed meaningfully on a relative basis (and yes – the trend is due to reverse).
stockcharts.com
As of June 30, 2023, the fund held 129 securities, with a significant chunk allocated to Corporate sector. The fund’s holdings are diversified across multiple industries, reducing the risk associated with any single sector. However, the geographic allocation is heavily tilted towards the United States, making up 90.16% of the total assets. The remaining portion is spread across Luxembourg, Canada, Netherlands, United Kingdom, Germany, and France.
Comparing BKLN with Similar ETFs
When comparing BKLN with similar ETFs, it’s important to consider factors such as performance, yield, and risk. For instance, the SPDR Blackstone Senior Loan ETF (SRLN) and the First Trust Senior Loan Fund (FTSL) are two funds that also invest in senior loans. Another comparable ETF is the iShares Broad USD High Yield Corporate Bond ETF (USHY), which also targets high-yield opportunities. However, unlike BKLN, USHY primarily invests in high-yield corporate bonds, which can behave differently than leveraged loans in certain market conditions.
For me, this is more of a macro argument. Credit spreads are too tight, and while some higher-yielding funds will perform better than others, the entire space likely would suffer in heightened risk-off dynamics. One of the primary risks associated with BKLN is credit risk. Since the fund invests in lower-rated loans, there’s a higher chance of default by the issuing companies, which could lead to significant losses. Interest rate risk is another potential concern. While the floating-rate nature of senior loans could offer some insulation against rising interest rates, rapid rate hikes could lead to higher default rates, especially for companies with significant floating-rate debt.
The Bottom Line
The Invesco Senior Loan ETF offers an attractive opportunity for investors seeking high income. Its focus on senior secured loans provides a measure of protection during market downturns and a potential hedge against rising interest rates. However, the fund’s credit and interest rate risks, coupled with its heavy concentration in the U.S. market, make it risky in the here and now. I’d hold off on this until after some kind of real stress takes place to then buy into.
Anticipate Crashes, Corrections, and Bear Markets
Are you tired of being a passive investor and ready to take control of your financial future? Introducing The Lead-Lag Report, an award-winning research tool designed to give you a competitive edge.
The Lead-Lag Report is your daily source for identifying risk triggers, uncovering high yield ideas, and gaining valuable macro observations. Stay ahead of the game with crucial insights into leaders, laggards, and everything in between.
Go from risk-on to risk-off with ease and confidence. Subscribe to The Lead-Lag Report today.
Click here to gain access and try the Lead-Lag Report FREE for 14 days.
Read the full article here
