High Yield Corp Vs. Bank Loans ETFs

July 15, 2014

3 Key Differences

There are three key differences, broadly speaking, between senior bank loans and other corporate debt, such as high-yield bonds:

Collateral: Senior loans are collateralized by firm assets. These assets are not tied to any other debt instruments, so if a company goes belly-up, these assets are liquidated to repay the senior loans before any other creditor can be repaid from the proceeds of the sale. This makes senior bank loans less risky than other forms of corporate debt.

Seniority: In the capital structure of the issuing company, senior bank loans are typically the highest-priority credits on a firm’s balance sheet. In the event of bankruptcy or liquidation, they’re repaid before any other type of financing—including high-yield debt. That seniority also translates into relatively lower yields because the less risk you take, the less you’re compensated for it.

Floating Rates: Senior loans are typically floating-rate instruments whose rates are often benchmarked to Libor. These rates reset regularly, with an agreed spread to the benchmark. As such, bank loans have minimal duration risk.

High Yield Has More Room To Run

Now, whether you’re investing in bank loans or high-yield corporate bonds, there’s no question that the hunt for yields is still raging, even as the market braces for higher rates ahead.

What’s interesting is that traditionally, high-yield corporate debt moves directionally with equities, while Treasurys move inversely, but this year, they have all moved higher somewhat in tandem. That’s unusual, Parish says, and makes it even harder for investors to figure out what to do about fixed-income exposure, credit risk or duration risk alike.

“Can we expect more of the same? No,” Parish told ETF.com. “The only way for the broad Barclays Agg to continue to rally would be for rates to continue to drop.”

That would mean 10-year Treasury yields would have to slide closer to 2.2 percent, a scenario in which equities would be hard-pressed to rally, Parish says. Still, he argues that the bull ride in high-yield debt is not quite over.

“Risk markets continually overshoot,” Parish noted. “There’s still room to eke out attractive returns in high-yield bonds.”

 

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