BKLN - BKLN: Good Place To Park Your Cash In The Short Term

2023-12-15 01:24:47 ET

Summary

• Invesco Senior Loan ETF is a high-yield fund that aims to generate income while maintaining share price stability.
• Senior loans have priority in repayment and are backed by tangible assets, making them less risky. Their floating rate also gives some price stability.
• BKLN has a high expense ratio and its distribution history has been inconsistent, but it currently offers a good dividend distribution yield of 8%.
• It's a decent place to park your money for a year or so but don't expect very strong results in the long term.

Invesco Senior Loan ETF ( BKLN ) is a high-yield fund with the goal of generating income while keeping share price stable. This may be a decent place to park your cash for the short term while you are trying to decide where to deploy that cash but its long-term performance is questionable so I might not put my money there for the long term.

The fund has been around for more than a decade and it delivered 49% in total returns while its NAV and share price decayed by about 16% during the same period.

First, what are senior loans? Senior loans are a special kind of loans often seen in corporate bond world with certain characteristics. First, senior loans typically get the first priority in terms of getting paid back. This applies to both interest payments made to service a debt as well as principal pay at maturity. A company must pay its senior debt before it pays almost everything else. These are bigger priority than dividends (both regular and preferred) and many other debt payments so they have a high likelihood of getting paid back unless a company goes bankrupt and has no assets to cover any of its debt.

Speaking of assets, that's another thing that typically sets senior debt apart from other types of debt. Senior debt is typically backed by a company's tangible assets and holders of senior debt typically get paid first before (almost) everyone else if a company's assets get liquidated. Then again keep in mind that book value of a company's assets can drop drastically during a bankruptcy and you might find out that your "asset backed debt" isn't so asset-backed after all. For example, if a company has borrowed $50 million backed by its factory which is also worth $50 million, once that company goes bankrupt, the factory might be only worth $10 million because it's not operational anymore and we now find out that only 20% of the debt is backed by actual tangible assets.

Third, senior loans tend to have lower interest coupons and these coupons tend to have floating rates. Since senior loans have the first priority to be repaid, they are considered "less risky" and thus their interest rate is lower. The fact that most (but not all) senior debts tend to be floating debt also makes their price more stable. Why? Because if you have a bond that has a fixed rate of 3% and interest rates climb to 4%, your loan will lose anywhere from 3% to 30% of its market price depending on how many years left until maturity. You'll still get your full money at the time of maturity unless something really bad happens but your price will fluctuate a lot during this time. Since floating rate loans adjust their rates over time, their market prices will not fluctuate as much.

Below chart shows how bond markets behaved in the last few years as compared to BKLN. Notice how bond prices dropped by more than 20% at one point while BKLN's price was more or less stable during this time. At one point it was down about -8% but it was mostly due to its dividends getting deducted from the fund's NAV.

This goes both ways though. Just as senior bonds did not drop in price during the bond bear market of 2021-2023, they are also less likely to see share price appreciation if bonds make a comeback and enter a new bull market. Since bottoming in late October, bond prices are up almost 8% on average while BKLN is only up about 1.59% during the same period. So if you are very bullish on bonds and want to take advantage of an upcoming bond rally, you don't want to be invested in BKLN. You want to be invested in something longer term like TLT to take advantage of lower rates in the future.

Typically banks, funds and institutions will hold senior debt. It's difficult and costly for retail investors to buy and hold these debt instruments so those investors who want exposure to senior debt instruments usually buy funds and ETFs like this one. This also explains why BKLN has a high expense ratio of 0.65% because it's not easy to replicate its portfolio as if replicating a stock based ETF.

The fund has a weighted average coupon of 8.16% and yield-to-maturity of 9.73% indicating a small discount on bond prices. It's still commanding a ~3% premium over the 3 month LIBOR rate which is very close to the Fed's fund rate of 5.5%. This could drop by about 75 bps next year based on the latest estimates but it's not likely to happen before Q3 at the earliest. The average maturity is about 4.38 years which makes this neither long term nor long term in terms of average maturity. Typically anything under 3 years is considered short-term and anything more than 5 years is considered long term. This fund's average maturity window puts it in the mid-term category which gives you a blend of medium risk with medium returns.

The fund currently holds close to 150 positions in corporate debt instruments. You might be surprised to see that it's largest holding accounting for almost 14% of its total weight is a government bond instrument but that's just where the fund holds its cash as collateral. You can think of this like the fund's cash position which also happens to yield about 5.5%. The fund's active positions include a lot of smaller companies like Peraton, McAfee and Hub International. Many of the fund's bond holdings belong to private companies that are not publicly traded but this doesn't tell us much in terms of whether these are good or bad companies. A company's finances could be good or bad regardless of who owns it and whether it is private or public.

One thing that makes me worried about this fund is its distribution history. The fund's dividends have fluctuated over time but didn't show much sign of growth in the long term. Bond funds don't come with much dividend growth anyways so this may be ok but distributions shouldn't drop much either. For example the fund had a distribution of $1.11 in 2019 when rates were close to zero but it only distributed $1.00 in 2022 when rates were much higher. On a positive note, it's been paying 15 cents per month in recent months which could give us an annualized distribution of $1.88 which would be the all-time high for the fund so things could look a bit better in the future. We will see how long that lasts though, especially with rates being expected to come down next year.

This is not a bad fund to park your money for a year or so and enjoy a dividend distribution yield of 8% while share price stays more or less stable if you are unsure about where to park your money or if you don't want to get into stocks yet, but you might find better deals elsewhere in the long run.

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