What is Bank Loan ETF ?
An Exchange traded fund is an active fund which seeks to track/outperform a benchmark index. The index is usually a popular barometer of the industry the ETF invests in. There have been various types of ETFs which invest in a variety of asset classes such as Gold, Overseas Equity Indices, and Corporate Bonds etc. Recently, ETFs on bank loans have also been issued. A Bank loan ETF is an Exchange traded fund which tracks a bank loan portfolio or a broader index which tracks the corporate bank loans. The need for a bank loan ETF emerged amid the demand of investors for interest rate hedges. An ETF is a user friendly instrument in which a retail investor can participate. A bank loan ETF should ideally track a widely followed index provided
The first bank loan ETF began trading in the US in March 2011. The ETF was launched by INVESCO PowerShares Capital Management. It was an ETF for corporate bank loans. It is based on the S&P/LSTA US Leveraged Loan 100 Index, which is a basket of 100 largest and most liquid loans from various high ticket borrowers. The senior loans usually are in connection with LBOs (Leveraged Buyouts) and Acquisitions. The borrowers include CIT, Bausch & Lomb, and Ford etc. Based on the historical data from 2002 to 2010, the annual yield of S&P/LSTA US Leveraged Loan 100 Index was about 6.9%. In about 1 month, this ETF had about USD 75 million
The equity markets have not been able to satisfy investors with their returns. Hence there has been a need for a Bank loan ETF in the markets. With the interest rates being closed to zero, the loans which are the underlying for such ETFs are demand as they pay floating rate based on the LIBOR (London Interbank Offer Rate). Many mutual funds which bought these loans have been in huge demand by retail investors. There has been an inflow of about USD 15 billion in 34 consecutive weeks according to Lipper, a fund tracking agency. The senior loans have higher priority over other loans and hence carry a relatively lower credit risk.
Several new companies plan to start such ETFs. Apollo Global Management started a closed ended fund which tracks senior floating rate loans. Guggenheim, another agency also has plans to start a bank loan ETF. The ETF plans to invest in adjustable rate debts which are known as senior loans. The benchmark index for this fund is the Credit Suisse Leveraged Loan Index. This ETF plans to invest in adjustable rate senior secured loans, adjustable rate revolving loans and senior secured bonds. State Street (SSga) also plans to start an ETF which plans to outperform S&P/LSTA US Leveraged Loan 100 Index. The fund is called SSgA Blackstone / GSO Senior Loan ETF. Market Vectors is also planning an Investment Grade Floating Rate Bond ETF. However, this could be categorized as a bond ETF rather than a bank loan ETF.
However, as per research firm, Morningstar, there could be significant tracking error in Exchange Traded Funds which track relatively illiquid loans. This is because active fund management might be hindered due to difficulty in buying and selling at the right time.