One of the fastest-growing breeds of income generators

Senior bank loan Exchange Traded Funds (ETFs) are emerging as one of the fastest-growing breeds of income generators. The most popular of these ETFs, the PowerShares Senior Loan Portfolio (BKLN), raked in $1.5 billion in the first three months of 2013 alone.

These ETFs track senior secured bank loans—variable-rate loans that are made by banks to non-investment-grade companies and secured by real estate or some other asset. The rate on the loans changes every 30 to 90 days and is usually pegged to the London Interbank Offered Rate (LIBOR).

Investors are attracted to these ETFs for a number of reasons, including recent yields of around 4%. When the rates on the portfolio loans rise, the ETF yields follow suit, which makes them especially attractive in a rising-rate environment. With a minimal correlation to fixed-rate bonds, senior secured bank loans also provide diversification for income portfolios.

Because these loans are senior to bonds and stocks in a company’s capital structure, investors go to the head of the payback line if a borrower hits tough times. Some investors have dubbed the loans “high yield light,” since the combination of floating rates, loan collateral and position in the corporate capital structure makes senior secured bank loans less risky than traditional high-yield bonds.

Although the ETFs are fairly new, institutional investors and mutual funds have been investing in senior secured bank loans for over 20 years. In a report issued in April, Morningstar, which has been tracking the bank loan sector since 1989, noted that the group typically shows positive performance even during recessions.

While there could always be another recession, there’s no reason to panic or avoid bank loan investments, says Morningstar ETF analyst Timothy Strauts.

Source:  Marla Brill, Financial Advisor magazine

PowerShares Senior Loan Portfolio (BKLN) is a component of the D2 Capital Management Multi-Asset Income Portfolio.

The information contained in this article does not constitute a recommendation, solicitation, or offer by D2 Capital Management, LLC or its affiliates to buy or sell any securities, futures, options or other financial instruments or provide any investment advice or service. D2, its clients, and its employees may or may not own any of the securities (or their derivatives) mentioned in this article.