A Better Way to High Yield
The first half of the year wrapped up last week in a way that is probably a bit different than how it was imagined six months ago.
The S&P 500 has been swooning since the third week of May, but closed the half up more than 12% year-to-date. Precious metals have been decimated this year, plunging in a nearly unimpeded death-dive to who knows how low.
And Fed Chairman Ben Bernanke recently delivered an opaque message of quantitative easing (QE) tapering. Of course, this tapering is subject to continued improvements in the economy. Moreover, QE could still be extended, or even increased, according to comments from New York Fed President William C. Dudley.
So what’s all the fuss about? Simply put, it is Mr. Market thriving in selective over-reaction mode again.
When first-quarter US gross domestic product (GDP) was revised 25% lower, from 2.4% growth down to 1.8% growth, the reaction was, shall we say, muted?
Yet all hell broke loose when Bernanke suggested that just quite possibly maybe if things improve economically (revising GDP down is not an improvement) the Fed might begin to “taper” its QE activities.
There was a lot of uncertainty in that message. And we, the market participants, know the results. But can we really blame the market for reacting that way?
It seems to me that all of the “recovery” is due to QE. As such, if QE goes bye-bye then so does the recovery—but that’s the catch.
If the recovery goes bye-bye (along with Chairman Bernanke?), would not then QE have to return? Or is the Fed ready to let the economy do its thing, good, bad or otherwise?
I do not see an economy that is capable of standing on its own. And with the breakdown in emerging markets, the perennial mess in Europe and the rogue’s gallery of international troublemakers still drawing attention to themselves, it is hard to imagine a significant and impactful withdrawal from QE.
Tapering would be a mistake and it seems the market agrees.
High Yield, Less Risk
There’s a class of debt known as senior loans—and senior loan funds have been pulling in billions of dollars this year.
Senior loan funds are composed of floating-rate, senior secured debt obligations issued by companies that are rated speculative, similar to junk bonds.
Of course, that tells us they can be risky and subject to default risk. A good idea is to buy them in a mutual fund or exchange-traded fund (ETF).
Risky as they may be, they are considered less so than junk (high yield) bonds because they are backed by collateral. That means they are closer to the front of the line if a default or bankruptcy occurs. And best of all senior loans have less interest-rate risk.
Unlike other fixed income, senior loan interest rates are usually pegged to a floating rate benchmark like LIBOR (London Interbank Offered Rate).
This means that their yields will rise (or fall) depending on that benchmark yield. Other types of debt are issued with a fixed rate that makes them sensitive to changes in market rates.
Translation: If/when the Fed stops QE and/or raises interest rates, most fixed income prices will fall as yields rise due to the inverse relationship between interest rates and bond prices.
So senior loan funds have been pulling in big bucks because they are perceived as safer in a rising interest rate environment. The biggest senior loan ETF, the PowerShares Senior Loan Portfolio (BKLN), has seen its assets under management grow from $2.7 billion to $4.2 billion this year alone.
There are a couple of newer offerings in the category, the SPDR Blackstone/GSO Senior Loan ETF (SNLN) and the First Trust Senior Loan Fund (FTSL), but BKLN is not just the biggest but also the oldest in the category—and it’s only been around since March of 2011.
All three funds have attractive yields: BKLN has a yield of 4.72%, SNLN has a yield of 5.79% and FTSL has a yield of 4.21%. And those yields look pretty good especially when compared to the iShares Barclays 20+ Year Treasury Bond ETF (TLT) yield of only 2.85%.
Although the senior loan funds did decline after the Fed announcement last week, they did less so than other fixed income. BKLN is down .6% while TLT is down 2.5% over the same period, losing almost one year’s worth of interest in less than two weeks.
Senior loan ETFs are a good category to consider adding to your fixed income portfolio for diversification and yield.
Steven Orlowski is a 20-year veteran of the investment business. He has worked for some of the most prestigious firms in the world in a variety of capacities, including portfolio manager, trader and high net worth financial planner.
The S&P 500 has been swooning since the third week of May, but closed the half up more than 12% year-to-date. Precious metals have been decimated this year, plunging in a nearly unimpeded death-dive to who knows how low.
And Fed Chairman Ben Bernanke recently delivered an opaque message of quantitative easing (QE) tapering. Of course, this tapering is subject to continued improvements in the economy. Moreover, QE could still be extended, or even increased, according to comments from New York Fed President William C. Dudley.
So what’s all the fuss about? Simply put, it is Mr. Market thriving in selective over-reaction mode again.
When first-quarter US gross domestic product (GDP) was revised 25% lower, from 2.4% growth down to 1.8% growth, the reaction was, shall we say, muted?
Yet all hell broke loose when Bernanke suggested that just quite possibly maybe if things improve economically (revising GDP down is not an improvement) the Fed might begin to “taper” its QE activities.
There was a lot of uncertainty in that message. And we, the market participants, know the results. But can we really blame the market for reacting that way?
It seems to me that all of the “recovery” is due to QE. As such, if QE goes bye-bye then so does the recovery—but that’s the catch.
If the recovery goes bye-bye (along with Chairman Bernanke?), would not then QE have to return? Or is the Fed ready to let the economy do its thing, good, bad or otherwise?
I do not see an economy that is capable of standing on its own. And with the breakdown in emerging markets, the perennial mess in Europe and the rogue’s gallery of international troublemakers still drawing attention to themselves, it is hard to imagine a significant and impactful withdrawal from QE.
Tapering would be a mistake and it seems the market agrees.
High Yield, Less Risk
There’s a class of debt known as senior loans—and senior loan funds have been pulling in billions of dollars this year.
Senior loan funds are composed of floating-rate, senior secured debt obligations issued by companies that are rated speculative, similar to junk bonds.
Of course, that tells us they can be risky and subject to default risk. A good idea is to buy them in a mutual fund or exchange-traded fund (ETF).
Risky as they may be, they are considered less so than junk (high yield) bonds because they are backed by collateral. That means they are closer to the front of the line if a default or bankruptcy occurs. And best of all senior loans have less interest-rate risk.
Unlike other fixed income, senior loan interest rates are usually pegged to a floating rate benchmark like LIBOR (London Interbank Offered Rate).
This means that their yields will rise (or fall) depending on that benchmark yield. Other types of debt are issued with a fixed rate that makes them sensitive to changes in market rates.
Translation: If/when the Fed stops QE and/or raises interest rates, most fixed income prices will fall as yields rise due to the inverse relationship between interest rates and bond prices.
So senior loan funds have been pulling in big bucks because they are perceived as safer in a rising interest rate environment. The biggest senior loan ETF, the PowerShares Senior Loan Portfolio (BKLN), has seen its assets under management grow from $2.7 billion to $4.2 billion this year alone.
There are a couple of newer offerings in the category, the SPDR Blackstone/GSO Senior Loan ETF (SNLN) and the First Trust Senior Loan Fund (FTSL), but BKLN is not just the biggest but also the oldest in the category—and it’s only been around since March of 2011.
All three funds have attractive yields: BKLN has a yield of 4.72%, SNLN has a yield of 5.79% and FTSL has a yield of 4.21%. And those yields look pretty good especially when compared to the iShares Barclays 20+ Year Treasury Bond ETF (TLT) yield of only 2.85%.
Although the senior loan funds did decline after the Fed announcement last week, they did less so than other fixed income. BKLN is down .6% while TLT is down 2.5% over the same period, losing almost one year’s worth of interest in less than two weeks.
Senior loan ETFs are a good category to consider adding to your fixed income portfolio for diversification and yield.
Steven Orlowski is a 20-year veteran of the investment business. He has worked for some of the most prestigious firms in the world in a variety of capacities, including portfolio manager, trader and high net worth financial planner.