Business of Bonds: Senior Loan ETFs Take the Spotlight

The Federal Reserve continues to hold fast to its highly data-driven, wait-and-see approach on rate policy. Last week’s FOMC meeting further bolstered the market’s belief in a lone rate-cut scenario, and senior loan ETFs have gained traction as elevated rate expectations spill over into the second half of the year.

Despite record rate volatility, senior loan ETFs have risen above the fray and emerged as a beacon of resilience. They’ve captured the attention of investors scouring the credit quality spectrum for lower volatility and higher yield. Senior loans boast some of the healthiest carry in the debt space. Compared to junk bonds, which are yielding 8%, senior loans are spouting a historically high yield of above 9% -- in some cases, nearing double-digit returns.

The additional 4% yield on top of Treasuries presents a tantalizing trade-off for those willing to take on more credit risk, given their below-investment-grade status. The floating-rate coupon also helps cushion the blow against rising rates and inflation. Consequently, senior loans tend to have less rate sensitivity than the broader bond market, preserving bond value and minimizing capital depreciation and income loss. They’re typically low duration -- with interest payments widely resetting every 30 to 90 days.

Short-term core and credit strategies help balance income and risk
Source: State Street Global Advisors

Strong institutional demand for senior loans, coupled with a strong economic backdrop, has driven credit spreads ever narrower. But tighter spreads can be justified by a stable, credit-friendly macroeconomic outlook and a steadily higher-for-longer rate environment. Additionally, the creditworthiness of senior loans not only benefit from their legal precedence over all other claims, but from a perceived tightening of bank lending standards over the past few years.