The so-called “Great Rotation” from bonds to stocks—appears to be taking longer than earlier expected. While there were increased inflows into equity funds earlier this year, the trend slowed down later on account of renewed worries about global growth and troubles in the Euro-zone.
Though ETF investors showed a clear preference for equity funds, most mutual fund investors continued to put money in bond funds as well. Additionally, most of the money going into stocks came from the cash lying on the sidelines. (Read: 3 Excellent ETFs for Income Investors)
However, it was clear that investors were getting increasingly worried about the interest rate risk in their bond portfolios. ETF flows during the first quarter show that more interest rate sensitive ETFs like iShares iBoxx $ Investment Grade Corporate Bond Fund (LQD) and iShares iBoxx $ High Yield Corporate Bond Fund (HYG) lost money, and funds with less interest rate sensitivity/shorter duration gathered assets.
Recent FOMC minutes meetings revealed that there is growing debate within the committee about continuation of asset purchases at current levels. Once the Fed slows down its purchases, interest rates will start to rise. In fact, the ten-year note did break the psychological barrier of 2% earlier this year but the yields declined later. Within the fixed income space, junk bonds appear to be at highest risk.
Investors looking for higher yields but concerned about the potential rise in interest rates should look at Senior Loan ETFs. (Read: 3 REIT ETFs you should not ignore)
Senior loans are secured by company’s assets and are thus lower in risk structure, even though these loans are mostly issued by companies with below investment grade credit. These are floating rate loans so they usually pay a spread over some benchmark rate like LIBOR. Thus, in the event of rise in interest rates, coupons on senior loans increase while the value of the investment remains stable. On the other hand, bonds lose value if the interest rates go up.
So, investors in senior loans or in senior loans ETFs get the benefit of high yields with protection against any interest rate rise. Further, they carry lower credit risk compared with most other assets with similar level of yield. Additionally senior loans have low correlations with other asset classes. (Read: 3 High Yield ETFs for your IRA)
PowerShares Senior Loan Portfolio (BKLN)
BKLN is based on the S&P/LSTA U.S. Leveraged Loan 100 Index which is designed to track the largest institutional leveraged loans based on market weightings, spreads, and interest payments.