Insights   •   Fixed Income

SPDR® Blackstone Senior Loan ETF (SRLN) – Q3 2021 Commentary

During the third quarter of 2021, SRLN returned 0.64% slightly underperforming both the Markit iBoxx USD Liquid Leveraged Loan Index by 19 basis points (bps) and the S&P/LSTA U.S. Leveraged Loan 100 Index by 34 bps on a NAV basis but recovered some performance over the quarter as Covid-19 Delta concerns subsided1,2.  

During the third quarter, SRLN slightly underperformed its benchmarks due to its overweight to lower-rated companies and assets in the re-opening trade. Debt of certain movie theaters, airline and travel companies all traded lower in early July on the proliferation of the Covid-19 Delta variant, as well as vaccine hesitancy.

The Fund recovered some performance over the quarter as Covid-19 Delta concerns subsided prompting a rally in those same lower-rated credits. SRLN was also able to realize gains in certain high conviction idiosyncratic credits, including movie theater and airline names, through a reweighting of the portfolio in July, leaving year-to-date (YTD) returns on a NAV basis ahead of its benchmarks.

Top contributors over the quarter were Envision Healthcare, DirecTV, and Team Health. Negative contributors were Altice Financing, Lumileds, and Altice France.*

SRLN received strong inflows in the third quarter, totaling $1.4 billion bringing the YTD total to $5.4 billion as of September 30, 2021.3 The Fund became the largest bank loan ETF, with a market cap totaling $7.7 billion through September 30, 2021.4

*This information should not be considered a recommendation to invest in a particular sector shown. It is not known whether the sectors shown will be profitable in the future.

Standard Performance

Quarter in Review

The U.S. loan market is recovering from an initial Delta sell-off in early July 2021 to return +0.98% over the quarter, outperforming both investment grade and high-yield indices as well as equities5. Performance was largely driven by a rebound in lower-rated CCC assets and re-opening credits which rallied as Delta concerns eased.

Technicals also supported performance as demand for loans easily soaked up supply, pushing average loan prices closer to par.6 Helped by increased M&A-backed loan supply, total institutional loan volume through the end of September rose to $487 billion, surpassing the prior high for the first three quarters in 2017, and within easy striking distance of the 2017 full-year record of $503 billion.7

Offsetting this was $46.7 billion of new collateralized loan obligation (CLO) issuances priced in the third quarter, the third consecutive period of record quarterly issuance. Issuance rose to $130 billion through the end of September 2021, topping the yearly volume record of $129 billion set in 2018. Retail loan funds contributed another $25.9 billion of net inflows to the market, double the amount posted in the second quarter.8

That same demand, combined with the low duration nature of loans, shielded U.S. loans from broader market volatility in September. The weakness was triggered by the Federal Reserve (the “Fed”) signalling that it would start to pare back its $120 billion bond buying program towards the end of 2021. Meanwhile, expectations for the Fed to start to hike rates in the next two years, prompted an increase in rates with the 10-year Treasury breaching 1.5%.9

We expect credit fundamentals to continue to improve and note that default volumes in the third quarter hit their lowest quarterly level since the fourth quarter of 2013. This year’s default volume is on pace to be the lightest in a calendar year since $4.5 billion defaulted in 2007. The leveraged loan default rate declined further in September to its lowest level since February 2012, and we expect default rates to remain low by historical standards over the near term.10

Portfolio Positioning and Outlook

SRLN remains overweight single-B and CCC rated assets relative to both the S&P/LSTA Leveraged Loan Index and the Markit iBoxx USD Liquid Leveraged Loan Index11. During September we slightly increased the Fund’s exposure to CCC-rated assets up from 14% in August to 17% and we continue to adjust portfolio positioning based on latest market views and developments.

Despite the increase in loan supply during the third quarter and into October, appetite continues unabated skewing technicals in favor of borrowers. There’s still a strong pipeline of CLO warehouses that will need to buy new loan assets, while mutual fund inflows continue apace into October.

As loan prices continue their march towards par and above, there’s a growing risk that borrowers will start to reprice deals amid buoyant demand. For reference, the all-in-spread for single-B rated loans fell 22 bps by early October from their August prices, while the yield to maturity dropped 23 bps to 4.69% in the same period.12

We are mindful of the potential for greater volatility across broader markets caused by mounting headwinds across the globe including rates, tapering, the energy crunch, supply chain issues and labor market shortages, as well as political maneuvering in Washington D.C.

However, we remain constructive on the loan market as a source of income and mitigant against interest rate volatility. Rate hike expectations may generate more inflows into senior loans given their floating rate nature and reduced duration risk compared with fixed-rate debt, particularly if high-yield investors rotate into the loan asset class in search of yield.

On a final note, bank loan ETFs offer an ongoing yield premium to high-yield ETFs, while expectations for the 10-year Treasury yield to move still higher should prove supportive for bank loan relative performance.13