New ETF Tracks Corporate Loans

NEW YORK (TheStreet) -- Invesco (IVZ) PowerShares last week launched the first senior loan exchange-traded fund, the Senior Loan Portfolio (BKLN).

There are have been closed-end funds and traditional mutual funds for investing in corporate loans for years, but some investors were eagerly awaiting an ETF that provides access to this space.

The basic idea is that the fund invests in loans that are either unrated or below investment grade.

The nature of this market is such that the interest rates are adjustable, which can help offset the risk of fixed income investing in a rising-rate environment.

When rates go up, bond prices go down. The longer the maturity of the bond, the more sensitive its price is to rising rates. However, for this new bank loan ETF, this should be much less of an issue, and maybe not even an issue at all.

The fund has 83 holdings and tracks the S&P/LSTA U.S. Leveraged Loan 100 Index. It charges a net expense ratio of 0.83%, and the yield is currently indicated at 4.97%, but of course the yield will fluctuate.

Some of the loans in the fund are to companies that will be familiar to most investors -- for example, Petco and First Data. There are also some names that will be less familiar, such as Texas Competitive Electric Holdings and Transdigm ( TDG).

As mentioned above this ETF has been eagerly awaited, but this is a tricky niche of the fixed income market. The financial crisis did a great job of exposing volatility characteristics of many segments, including the senior loan space.

One model for this space is the Invesco Van Kampen Sr Loan Fund ( VSLAX). The fund has more than $1 billion in assets under management and got crushed in 2008, dropping about as much as the S&P 500, with a 47% decline at its low.

Additionally, I would note that the ETF structure creates the potential for the market price of the fund to deviate from the fund's intraday indicative value during periods of extreme market behavior.

This was the case with many bond ETFs during the immediate aftermath of Lehman Brothers' collapse. This potential exists because the ETF is more liquid than the holdings within it. This is a normal market function, but finding out about this risk as it is happening in real time is a situation most people would want to avoid.

Clearly the odds of another meltdown like the one in 2008 are low, but this is space is unlikely to offer any shelter should that type of extreme market behavior happen. This does not mean the PowerShares Senior Loan Portfolio is a bad fund, but any investment product has its benefits and weaknesses, and understanding both is crucial for good decision making.

Lastly, there is a philosophical point to investing that arises with a fund like this. Do you have fixed income exposure because you want to balance out the volatility of the equity portion of your portfolio? If the answer is yes, this fund may not be suited for you.

But there are investors interested in taking risk in their fixed income portfolios in pursuit of capital gains or for above-market yields, and for them, this fund would have more utility.

At the time of publication, Nusbaum had no positions in securities mentioned.

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Roger Nusbaum is a portfolio manager with Your Source Financial of Phoenix, and the author of Random Roger's Big Picture Blog. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Nusbaum appreciates your feedback; click here to send him an email.

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