SPDR® Blackstone Senior Loan ETF [SRLN] – Q1 2021 Commentary

During the first quarter of 2021, SRLN outperformed the Markit iBoxx USD Liquid Leveraged Loan Index by 62 bps and outperformed the S&P/LSTA U.S. Leveraged Loan 100 Index by 69 bps on a NAV basis.

During the first quarter, SRLN outperformed its benchmarks largely due to its tactical overweight to assets rated single-B or below, including credits with exposure to an economic reopening. Many of these were added at discounted levels during 2H 2020 and have outperformed as line-of-sight towards a normalization has progressed. By rating, outperformance compared to the primary benchmark was driven by positive credit selection among single-B rated assets and an overweight allocation to CCCs, whereas outperformance relative to the secondary benchmark was driven by positive credit selection across all ratings tiers. Positive credit selection within the consumer discretionary, healthcare and industrials sectors also contributed to relative outperformance, with particularly strong alpha contribution in these sectors from Carestream, Travelport, Team Health, American Airlines and Petco.

Standard Performance

Quarter in Review
US loans outperformed all other categories of fixed income in the first quarter of 20211 against a backdrop of an improving economic recovery, generous stimulus and expectations for a sharp increase in consumer spending as vaccinations reach critical mass. In reaction, interest rates moved sharply higher with the 10-year Treasury ending March at 1.74%, up 81 bps since the end of 2020.2 This caused equity and fixed-rate credit markets to experience pockets of volatility, but loans were relatively unfazed due to their floating rate coupon and near-zero duration.

Year-to-Date 2021 Returns

Retail investors reacted to the steepening Treasury curve by withdrawing $10.6 billion from high yield funds in the quarter compared to net retail inflows of $14.0 billion for US loans.3

In a sign of improving credit fundamentals, default volume was muted in the first quarter and the last-twelve-month default rate decreased 61 bps, ending at 3.34%, an eleven-month-low.4

As we pass the one-year mark since COVID-19 drove historic dislocations in global markets, our outlook remains optimistic. Vaccination rates have increased dramatically in the US and UK, and, although we continue to closely monitor variants as well as elevated case counts in certain pockets of the world, the line-of-sight to reopening and recovery in most developed economies has not been clearer.

Markets are increasingly pricing in a robust economic recovery, but with a clear divergence between performing and stressed assets. Much of the recent outperformance has been driven by a recovery in stressed, lower-rated issuers in COVID-impacted sectors. We believe this wave may be cresting in credit as the momentum of the reopening trade has carried bonds and loans closer to fair value. As a result, careful credit selection will play a larger role in determining performance in the coming months and quarters.

Portfolio Positioning and Outlook
SRLN is currently overweight single-B and CCC-rated assets relative to benchmarks. This positioning is based in part on our view that loan market technicals will remain constructive, with continued demand being driven by new and existing CLOs as well as loan mutual fund and ETF inflows. We expect loan supply to return towards historically normal levels following depressed issuance during much of 2020. SRLN is also market-weight or overweight certain credits with exposure to the economic reopening, many of which continue to trade at discounts to par that we believe are attractive on a risk-adjusted basis. We remain optimistic about these positions but continue to closely monitor risks to the economic reopening, including vaccine hesitancy and the proliferation of SARS-CoV-2 variants.