Launching into High Yields: The BKLN Story 📈

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Welcome back to this week's ETF UNO! Fixed-income investment products are usually less known to many investors due to their complexities. However, we lose opportunities by lacking related knowledge. For example, senior loans are an exciting asset class known for their floating rate feature and seniority in capital structure. We will look at the Invesco Senior Loan ETF (BKLN) today to understand what makes this ETF an attractive choice for investors, how it works, and why it could be a smart option in the current market environment. We will also provide a balanced look at the potential downsides and offer insights on whether this ETF could be a good fit for you.

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What is BKLN?

Senior loans are debt financing obligations companies issue to fund various corporate activities, such as acquisitions, refinancing, or general corporate purposes. These loans are called "senior" because they sit at the top of a company's capital structure, meaning they take priority over other forms of debt and equity in the event of a default or bankruptcy.

This is where BKLN ETF comes into play. By investing in senior loans, BKLN allows you to tap into the high-yield potential of this asset class without the complexities of navigating the individual loan market. Instead, BKLN tracks the Morningstar LSTA US Leveraged Loan 100 Index, representing the largest and most liquid senior secured loans available.

Floating Rate: A Shield Against Rising Interest Rates🛡️

Senior loans, with their unique floating rate feature, stand out as a compelling investment option in a rising interest rate environment. This feature, which becomes particularly advantageous in such an environment, is a key reason for their appeal. Here's why:

• Interest Rate Sensitivity: Traditional fixed-rate bonds tend to lose value when interest rates rise, as their fixed payments become less attractive than newly issued bonds with higher rates. With their floating rates, senior loans can adjust their interest payments periodically, usually every 30 to 90 days, potentially protecting investors from the negative impact of rising rates.

• Low Duration: Duration measures a bond's sensitivity to interest rate changes. Compared to traditional bonds, senior loans typically have very low durations. This low duration means that senior loan prices tend to be less volatile when interest rates fluctuate.

• Potential for Higher Yields: As interest rates rise, the yield on senior loans can increase, potentially providing investors with higher income. This contrasts fixed-rate bonds, where yields remain static unless the bonds are traded on the secondary market.

Often considered a "floating rate" ETF, BKLN is a good hedge against inflation and rising interest rates because it holds only senior loans.

Senior Loans: Prioritised Debt in the Capital Structure🔝

As mentioned above, the term "senior loan" reflects their priority in the capital structure — they must be repaid before other forms of debt if the borrowing company faces bankruptcy or financial distress.

In the event of a company's default or bankruptcy, senior loans are typically the first to be repaid. This priority position provides an additional layer of security for investors, as it increases the likelihood of recovering the invested capital.

Senior loans are usually secured by the borrowing company's assets. This collateral can include physical assets (like equipment or real estate) or financial assets (like accounts receivable). The presence of collateral further enhances the security of senior loans.

BKLN at a glance

ETF Issuer: Invesco

Inception: 03/03/2011

Asset Class: Fixed-Income

Underlying Index: Morningstar LSTA US Leveraged Loan 100 Index

Geographical Focus: U.S.

Expense Ratio: 0.67% (as of last data point)

Dividend Yield: 8.62% (as of last data point)

Distribution Frequency: Monthly

Historical Performance

To genuinely appreciate BKLN's role in a portfolio, it's essential to examine its historical performance. Since its inception in March 2011, BKLN has navigated various market conditions, exposing investors to the senior loan market through bull markets, bear markets, and everything in between.

Here's a snapshot of BKLN's performance over the years:

• Steady Income Stream: One of BKLN's most attractive features is its consistent dividend payments. Since its inception, the fund has distributed dividends monthly, providing investors with a reliable and secure income stream and enhancing their sense of security.

• Yield Performance: In recent years, particularly from 2023 to 2024, BKLN has offered an attractive dividend yield. As of early 2024, the 30-day SEC yield stood at approximately 8.5%, significantly higher than many traditional fixed-income investments.

• Performance During Market Stress: BKLN's resilience during periods of market stress, such as the COVID-19 pandemic in 2020, is a testament to its strength. Despite experiencing significant price declines along with other risk assets, BKLN demonstrated a relatively quick recovery as markets stabilized and liquidity returned to the loan market, instilling confidence in its stability.

ETF Radar View

The radar chart below shows the general characteristics of the ETF:

Top 3 Reasons to Invest

1. High-Income Potential: BKLN allows investors to access potentially higher yields than traditional fixed-income investments. The fund's focus on senior loans, which typically offer higher yields due to their association with below-investment-grade borrowers, can be attractive for income-focused investors.

2. Interest Rate Protection: BKLN's floating rate structure provides built-in protection against rising interest rates. As rates increase, the yield on the underlying senior loans typically adjusts upward, potentially benefiting investors. This feature makes BKLN an interesting option for those concerned about the impact of rising rates on their fixed-income holdings.

3. Breaking Barriers: Senior loans have traditionally been the domain of institutional investors due to high minimum investment requirements and complex trading and settlement processes. BKLN breaks this barrier by democratising access to this asset class, allowing individual investors to gain exposure to a diversified portfolio of senior loans with the ease and liquidity of an ETF structure.

Top 3 Reasons Not to Invest

1. Liquidity Concerns: The senior loan market can sometimes experience reduced liquidity, especially during periods of market stress. This could impact BKLN's ability to meet redemptions or accurately price its holdings. In extreme cases, this could lead to the ETF trading at a significant premium or discount to its net asset value.

2. Complexity: Senior loans are more complex than traditional bonds. They often come with specific covenants and terms that can be difficult for individual investors to understand fully. While the ETF structure simplifies access, it doesn't eliminate the underlying complexity of the asset class.

3. Interest Rate Floor Effect: Many senior loans have interest rate floors, meaning the interest rate won't decrease below a certain level even if the benchmark rate falls. This can limit the downside protection typically associated with floating-rate instruments in a falling-rate environment.

💸 Unlocking High-Yield Potential in Senior Loans

BKLN offers a unique proposition for investors seeking high-income potential, interest rate protection, and portfolio diversification. Its focus on senior loans provides access to an asset class traditionally reserved for institutional investors, potentially enhancing the sophistication and diversification of individual portfolios.

Like all investments, the BKLN ETF comes with risks, such as credit risk from below-investment-grade issuers, potential liquidity concerns, and the complexity of underlying assets. Investors should consider these factors against possible benefits.

Successful investing requires continuous learning and adaptation. Join the ETF UNO community for valuable insights, expert analysis, and a supportive network of like-minded investors. Happy investing!

DISCLAIMER: This article is for informational purposes only and does not constitute investment advice. Always conduct your own research and consider consulting with a financial advisor before making investment decisions.