SRLN: A Perfect Case For Active Management

May 21, 2013

Sometimes an active strategy comes along that makes perfect sense.

The Fed’s indefinite commitment to interest-rate suppression has gone global, with interest-rate cuts being deployed by all manner of central banks.

The reaction from investors and issuers alike has been predictable: Search and seek out yield in any manner possible, and SRLN is ringing the bell.

State Street Global Advisors launched a first of its kind, actively managed senior loan ETF—the SPDR Blackstone/GSO Senior Loan ETF (NYSEArca: SRLN), just over a month ago. In that short window, the ETF has snatched up assets in a way that few launches have in recent years: more than $200 million in assets.

The fact that SRLN is actively managed is certainly relevant to the fund’s success, given how short the list of actively managed ETF success stories is. But the asset class that SRLN targets, senior loans, is more telling.

Senior loans are a subset of the credit market that generally offer investors priority claim on assets in the event of bankruptcy or default. That explains the “senior” moniker of the fund, but stops short of explaining the appeal of these instruments.

After all, senior loans are subinvestment-grade debt securities, and it’s not as if there’s a shortage of high-yield bond funds on the market.

The appealing part, at least on the face of it, is the regular resets of senior loans. Most, if not all, senior loans are benchmarked to Libor, and their rates are reset every three months. This feature insulates them from what appears to be an inevitable rise in interest rates.

As rates go up, so too do yields on senior loans. Of course there’s the potential for a lag—as long as three months—but the allure of higher, market-adjusting yields is clearly striking a chord for many investors.

So why design such an ETF to be active? After all, the rates on senior loans will adjust over time as interest rates ebb and flow. The answer to that question, in the eyes of the issuer at least, comes down to the market structure.

The fixed-income market is significantly more opaque than the market for equities. Unlike stocks, there’s no central marketplace for bonds, and therefore no uniform real-time price available. This holds true for Treasurys, investment-grade corporate debt as well as foreign sovereign debt. As a result, the onus is on the money manager or investor to determine the fair price of a bond.

If the success of the Pimco Total Return Fund (PTTRX) and its exchange-traded sibling, the Pimco Total Return ETF (NYSEArca: BOND) are any indication, these market inefficiencies can lead to real opportunities.


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