In the eight years> since I first wrote about senior loans, also known as bank loans, floating-rate loans or leveraged loans, the market for these assets boomed, and then like everything else credit-related, imploded during the market downturn. In 2009, leveraged loans that price at par, or $1, were trading at an unprecedented 59 cents.
Senior loans are unique. They have the highest claim on a company's assets, so in the event of a bankruptcy, senior loan investors are first to be made whole. In addition, the interest paid on senior loans "floats," adjusting monthly or quarterly along with changes in interest rates. That nuance makes senior loans one of the few credit-oriented instruments that can do well when interest rates rise.
Bank loans are still not as popular as other income alternatives such as energy limited partnerships or foreign real estate, but their ranks are expanding with investors' growing appetite for income. Roughly a third of CEFConnect's database of senior-loans funds was launched after 2006, including recent high-profile IPOs like Blackstone/GSO Senior Floating (BSL)
A new milestone was recently passed with the debut of PowerShares Senior Loan Portfolio (BKLN),
Generally, funds only come to market when they can be sold, so this isn't a launching that could have happened amid bank bailouts just a few years back. So while I'll continue to monitor this new ETF, I'm hesitant to commit to a focused new position right now given the huge bullish swing in investor sentiment toward senior loans.
You see it in three of ETF's top four holdings, which happen to be the shares of other closed-end senior loans funds, all which now trade at a premium to their underlying net asset values. While often frustrating as an investor, the premiums and discounts for closed-end funds can indicate the public's interest for a particular asset class.
For example, back in 2001, many closed-end-funds investing in emerging markets traded at discounts of up to 22%, reflecting investor doubt. Back then it was Cisco the public was interested in, not Chile.
In similar fashion, the discounts once present in senior-loan funds during the market collapse have evaporated completely.
Take ING Prime Rate Trust (PPR),
First Trust Senior Floating Rate (FCT), also held in the PowerShares ETF, trade for a slight 0.14% premium to its NAV, a huge rebound from the 35% discount during the downturn.
Invesco Van Kampen Senior Income (VVR)
Senior Loans Correlation to: (10-year)
As we noted a few weeks back, even "conservative" income investors tend to be a bizarrely "all or nothing" bunch. And in terms of diversifying an income-oriented portfolio, the asset class still holds promise. Senior loans show a negative correlation with intermediate government bonds and a weak connection to most other fixed income, making it an ideal component of a broad income-oriented portfolio.
Just as high-yield bonds have become a common holding for stock investors searching for income, you'll likely see senior-loan funds enjoy a similar boom among income investors angling for growth when interest rates finally start to rise.
Jonathan Hoenig is managing member at Capitalistpig Hedge Fund LLC.