FTSL - FTSL: Senior Loan ETF With Growing 7.0% Dividend Yield Low Rate Risk

2023-09-21 05:13:24 ET

Summary

• FTSL focuses on senior loans, offers a 7.0% dividend yield, and has low interest rate risk.
• The fund has above-average credit risk and an expense ratio of 0.86%.
• There are other senior loan ETFs with lower expense ratios and higher dividend yields, making FTSL a less attractive investment opportunity.

In keeping with my coverage on variable rate ETFs, thought to write an article on the First Trust Senior Loan Fund ( FTSL ). FTSL focuses on senior loans, sports a strong, growing 7.0% dividend yield, has very low interest rate risk, and has outperformed during the current hiking cycle. On the other hand, the fund's credit risk is above-average, as is the fund's 0.86% expense ratio.

Although I'm bullish on senior loans as an asset class due to their high yields, FTSL's expenses seem excessively high. I would much rather invest in the Franklin Senior Loan ETF ( FLBL ), with a much lower 0.45% expense ratio, and a higher 8.0% dividend yield. As such, I would not invest in FTSL.

Senior Secured Loan Basics

FTSL is an actively-managed ETF focusing on senior secured loans, securities with a very specific set of characteristics.

Senior secured loans are senior to all other company loans and liabilities, meaning they are the first to be repaid in the event of bankruptcy.

Senior secured loans are secured with company assets, meaning investors are pledged to receive real assets in the event of a bankruptcy.

Senior secured loans are effectively always variable rate loans, and so see higher coupon / interest rate payments when the Federal Reserve hikes rates.

Senior secured loans are generally non-investment grade loans, issued by smaller, less mature, riskier companies.

FTSL focuses on senior loans, and so exhibits the characteristics above. With this in mind, let's have a look at the fund itself.

FTSL - Basics

• Investment Manager: First Trust
• Expense Ratio: 0.86%
• Distribution Yield: 7.04%
• Total Returns CAGR 10Y: 3.44%

FTSL - Overview

FTSL is an actively-managed ETF focusing on senior secured loans, with smaller investments in bonds. From what I've seen, some of these bonds are classified as bonds, but are closer to senior loans in their characteristics.

FTSL's portfolio is reasonably well-diversified, with investments in 177 loans from several industry segments.

Credit quality is quite low, with the fund focusing on non-investment grade issuers, and with an average credit rating of B.

FTSL's credit ratings are indicative of relatively weak, risky issuers. In most cases, these issuers have no difficulties paying back their loans right now , but might run into issues if economic or industry conditions were to deteriorate. Default rates are low on an absolute basis, at 0.85% right now, 2.0% - 3.0% long-term, as per S&P . Default rates are higher than those of most bonds, and tend to spike during downturns and recessions. Due to this, FTSL tends to experience sizable, above-average losses during downturns, as was the case in 1Q2020. Losses were comparable to those of high-yield corporate bonds, however.

Risky bonds and loans tend to sport strong yields, and FTSL is no exception. The fund currently sports a 7.0% dividend yield, and an 8.4% SEC yield, both strong, higher-than-average figures.

Importantly, FTSL's dividends are seeing massive growth, over 89% these past twelve months, courtesy of Federal Reserve hikes. Further growth is likely, due to recent hikes, and due to the possibility of future hikes, but much will depend on how Federal Reserve policy and economic conditions continue to evolve.

FTSL's senior loan holdings are variable rate, and so have very little interest rate risk. The fund's duration stands at 0.49 years, much lower than average, a bit higher than that of T-bills and other cash alternatives. Still, duration is quite low.

FTSL's low duration and interest rate risk serves to reduce losses when interest rates are rising, leading to outperformance during the same. FTSL itself has outperformed since early 2022, when the Fed started to hike, as expected.

FTSL's strong, growing dividends, very low interest rate risk, and recent outperformance, are all important benefits for the fund and its shareholders and make the fund a solid investment opportunity. Importantly, these are all really benefits of its underlying asset class, senior loans, and so shared by most relevant senior loan ETFs, including BKLN and the SPDR Blackstone Senior Loan ETF ( SRLN ). Due to this, thought to have a quick look at some of the fund's similarities and differences to these funds, to try and ascertain which is strongest / weakest.

FTSL - Peer Comparison

Similarities to Peers

Strong, Growing Dividends

FTSL's dividends are stronger than those of most bonds and bond sub-asset classes, but the same is true for BKLN and SRLN. FTSL's dividend yield is technically lower than that of BKLN, but this is mostly due to an abnormally large dividend payment in December for the latter. SEC yields are also lower, however.

Although FTSL's dividends are a bit lower than those of its peers, all these funds have strong, above-average, growing dividends. This is an important similarity, and benefit, for shareholders.

Very Low Interest Rate Risk

FTSL focuses on variable rate securities with very low interest rate risk, as do most of its peers. From what I've seen, FTSL's interest rate risk is a bit higher, due to greater investments in fixed-income bonds. These are only a small portion of the fund's portfolio, so the effect is quite muted.

Due to the above, FTSL and its peers have all outperformed since early 2022, when the Fed started to hike. FTSL very slightly underperformed BKLN, slightly outperformed SRLN. The fund's marginally higher interest rate risk did not seem to have a material impact on the fund's performance.

High Credit Risk

FTSL focuses on senior loans, which are generally issued by non-investment grade issuers. The same is true for BKLN and SRLN. Due to this, these three funds all underperform during downturns and recessions, as was the case in 1Q2020. FTSL performed somewhere in the middle.

Advantages to Peers

Slightly Stronger Performance Track-Record

FTSL's performance track-record is slightly stronger than those of its peers, with the fund slightly outperforming since inception, and for the past three years. BKLN has outperformed for the past year, however.

From looking at FTSL's holdings and strategy, and based on prior knowledge of BKLN and SRLN, it seems that FTSL's higher returns were due to some small management alpha / active management.

Notwithstanding the above, these three funds do have broadly similar performances.

Disadvantages to Peers

Slightly Higher Expenses

FTSL has a 0.86% expense ratio, compared to 0.65% for BKLN, and 0.70% for SRLN. FTSL's marginally higher expenses means marginally lower total returns, a negative for the fund and its investors. Although the impact of this is quite small, it is almost certain to occur. Expenses necessarily decrease returns, while the same is not necessarily true of a performance track-record, or of dividends (can be cut).

In my opinion, FTSL does not significantly differ from its peers, and so does not provide a materially stronger, or weaker, value proposition than them. I see very few reasons to pick FTSL over its peers, or vice versa.

Conclusion

FTSL focuses on senior loans, sports a strong, growing 7.0% dividend yield, has very low interest rate risk, and has outperformed during the current hiking cycle. On the other hand, the fund's credit risk is above-average, as is the fund's 0.86% expense ratio. In my opinion, other senior loan ETFs offer comparable, but stronger, value propositions, so I would not invest in FTSL.

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