On the one hand, senior loans offer higher initial yields than many other fixed income products. On the other hand, they have the ability to raise that yield as inflation increases. This duality makes them an ideal holding for many investors looking to boost their income. There are some caveats.
For one thing, they are riskier than traditional corporate bonds. The average senior loan is issued to firms in the ‘junk’ ratings category (i.e., those rated BB+ or below by Standard and Poor’s or Ba1 or below by Moody’s Investors Services). So, Microsoft or Walmart aren’t the kinds of firms issuing senior loans.
Secondly, buying them individually is nearly impossible unless you’re an institutional investor or ultra-high-net-worth investor. It takes millions of dollars to purchase them and cobble together a portfolio to reduce risk. Luckily, there are numerous funds — both active and passive — that allow investors to participate in the sector.
Finally, senior loan investors do need to worry about taxes. Interest income from senior loans count at ordinary income rates. So, holding senior loans in a tax-deferred or tax-free account is best.
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In terms of ETFs, both the Invesco Senior Loan ETF (BKLN) and the SPDR Blackstone Senior Loan ETF (SRLN) are the two largest in the sector. BKLN offers a passive/index-hugging approach, while SRLN is active. Both feature billions in assets, swift trading volume, and access to hundreds of senior loans all for a low cost. Better still, the ETFs yield 3.29% and 4.76%, respectively.
Mutual funds have often been a prime stomping ground for senior loan funds. Active management can play a huge role in fixed income returns as credit research is often subjective and based on skill. There are more than 50 mutual funds in the category, with the Fidelity Floating Rate High Income (FFRHX), T. Rowe Price Floating Rate (PFFRX ), and Voya Senior Income A (XSIAX ) all earning top marks from ratings agencies. Like the previous ETFs, investors can get access to a wide portfolio of loans, high yields, and inflation protection.
Perhaps the best part of either choosing ETFs or mutual funds is that these vehicles often pay their dividends monthly.