EC Revisiting An Old ETF Income Theme – Bank Loans

There is no doubt that 2016 has been a good year for ETF investors directing their capital towards income-generating asset classes. The combination of a rising stock market and falling interest rates have helped push prices higher across virtually every segment of the economy. This of course has depressed current yields. But on a total return basis, you are looking fairly good as long as you didn’t do something foolish like sell in February and remain in cash. 

In early August, I wrote an article about the scarcity of value in income generating ETFs due in large part to this broad push higher.It essentially broke down the current landscape from both a yield and performance category across stocks, bonds, and alternative assets. I like to analyze these trends to pinpoint areas that look overheated and those that may offer greater hope for the future.

The two strongest income producing sectors were emerging market bonds and REITs. Obviously these areas were showing signs of technical strength, but also give me pause for their susceptibility to a sharper pullback. Much of the momentum has been driven by a stretch for yield (EM) and a perception of low-volatility and safety (REITs). Two trends that can easily turn and catch late-adopters off guard if interest rates attempt even a modest nudge higher.

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Furthermore, the areas of slow growth or outright negative returns were centered on international dividend paying stocks and master limited partnerships. Both of these sectors potentially offer greater long-term value on a relative basis, but are also much higher up the risk scale as well.

Right in the middle of the pack was an area I hadn’t considered in quite a while – bank loans. These instruments became widely known during the 2013 taper tantrum as a potential way to sidestep rising interest rates. Their weakness is more aligned with credit risk and liquidity (smaller market) than a typical investment grade fixed-income security.

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