The Good Brigade I last covered the Franklin Senior Loan ETF (BATS:FLBL) in late 2023. In that article, I argued that FLBL’s strong, growing dividends and comparatively cheap expenses made the fund a buy, and slightly superior to other senior loan ETFs. Performance has been reasonably good since, with the fund seeing 7.2% in total returns and some dividend growth. FLBL has outperformed most other bonds and bond sub-asset classes, too, including most of its senior loan peers. FLBL’s 8.3% dividend yield remains high, its 0.45% expense ratio below-average, and so the fund remains a buy. As senior loans are variable rate investments, the fund should see swift dividend cuts as the Fed cuts rates later in the year. FLBL trades with a healthy spread to bonds of comparable credit risk, so I believe that dividends should remain competitive for several years. More dovish investors might disagree. FLBL – Overview and Analysis Strategy and Portfolio FLBL is an actively managed ETF focusing on senior loans, which are senior secured variable rate loans from smaller non-investment grade corporations. FLBL provides diversified exposure to these investments, with more than 250 holdings from most relevant sectors. As the fund is actively managed, returns and yields could, potentially, be higher than those of senior loan index ETFs, including BKLN. I’ve personally found many effective fixed-income funds which do seem to generate sustainable alpha, as seems to be the case for FLBL. But more on the fund’s performance later. Data by YCharts So, FLBL is a simple actively managed senior loan ETF. Let’s now look at some of the characteristics and benefits of these holdings and approach. Strong 8.3% Dividend Yield Senior loans currently yield more than almost all bonds and bond sub-asset classes, courtesy of Federal Reserve hikes: JPMorgan Guide to the Markets …and the same is true for FLBL: Data by YCharts FLBL’s dividends are slightly below those of its peers, however. Seeking Alpha – Table by Author The above is partly due to normal ETF dividend volatility, with the fund’s yield dropping in late May (with no significant change in share prices). Data by YCharts ETF dividends are almost always covered by underlying generation of income, and that seems to be the case for FLBL too, as evidenced by the fund’s 8.5% SEC yield. SEC yields are a standardized measure of a fund’s underlying generation of income, explicitly excluding capital gains, ROC distributions, and the like. FLBL Considering the above, FLBL’s dividends should remain flat in the coming months. Significant changes in market conditions could obviously change this, but I’m not expecting anything of the sort. FLBL’s strong 8.3% dividend yield is the fund’s most significant benefit, key advantage relative to other bonds, and core investment thesis. FLBL’s senior loans are variable rate investments, and so have significantly benefitted from past Fed cuts. This is reflected in the fund’s strong dividend growth figures: Seeking Alpha Growth has been higher than average, too. As an example, FLBL’s dividends have grown almost 10x more than those of the iShares iBoxx $ High Yield Corporate Bond ETF (HYG), the largest high-yield bond ETF in the market, at the 3y mark. Growth has been more than twice as high these past twelve months. Seeking Alpha The corollary of the above is that FLBL’s dividends should decline as the Federal Reserve starts to cut rates. I’m a big believer in higher for longer, so don’t believe this to be a significant short-term risk. More dovish investors might disagree. At current spreads, the Fed would have to cut rates by 2.8% or more for the fund to start yielding less than high-yield bonds / HYG. As such, I believe that FLBL’s dividends should remain competitive for several years, even if the Fed starts to cut rates later in the year. Interest Rate Risk FLBL’s senior loans are variable rate investments, with negligible interest rate risk. Due to this, the fund’s share price should remain (mostly) stable even as interest rates move, unlike that of most other fixed-income ETFs. As an example, FLBL’s share price is down only 2.0% since early 2022 when the Fed started to hike. Other bond ETFs are down double-digit. Due to this, FLBL has significantly outperformed since the Fed started to hike. Data by YCharts On the flip side, the fund should underperform when rates decrease. Excluding the pandemic, the last time this occurred was during 2019, during which FLBL underperformed, as expected. Data by YCharts Importantly, most investors expect several rate cuts right now, and are pricing bonds accordingly. Due to this, bond prices might not necessarily be impacted by rate cuts. Slow, methodical rate cuts should have limited impact, significant, swift rate cuts should have a significant impact. As such, I’m not expecting FLBL to underperform in the next year or so, Fed rate cuts notwithstanding. Credit Risk FLBL’s senior loans almost always come from non-investment grade issuers, with weak credit quality and ratings. The fund itself focuses on loans rated B, a notch lower than the senior loan / high-yield bond average of BB. FLBL The issuers of these loans are generally able to meet their financial obligations without issues right now, but some would have difficulties if economic conditions were to deteriorate. So, default rates should spike during downturns and recessions, as should losses. Expect the fund to underperform during these scenarios, as was the case in early 2020, the onset of the coronavirus pandemic. Data by YCharts Some fixed-income securities and ETFs are able to benefit from lower rates, which almost always occur during recessions. As FLBL focuses on (variable rate) senior loans, it does not benefit from lower rates. These issues were partly responsible for the fund’s underperformance during the pandemic, especially in medium term, as markets settled, and in comparison to high-yield bonds. The above means that FLBL can’t really be used to hedge an investor’s equity, unlike treasuries (especially long-term treasuries). Treasuries have been positively correlated to equities for quite a while now though, so even these are ineffective hedges, right now at least. Expenses FLBL’s key advantage relative to senior loan peers is its comparatively low 0.45% expense ratio. Senior loan ETFs are much pricier than average, and although FLBL is a bit expensive, it is the cheapest (least expensive) in this sector. Seeking Alpha – Table by Author Lower expense ratios are an important benefit for shareholders. Choosing cheaper funds is also one of the only surefire ways for investors to boost their returns. Choosing high-yield funds is riskier, and dividends are sometimes cut. Factor investing, including value investing, is very hit-or-miss, as are trades. Fees always decrease returns, so avoiding these always boosts (decreases by less) returns. Due to these issues, I almost always put a great importance on an ETF’s fees. Performance Track-Record FLBL’s performance track-record is reasonably good, with the fund outperforming most bonds and bond sub-asset classes since inception. Returns have been particularly good these past three years, on both an absolute and relative basis, as rates have risen. Seeking Alpha – Table by Author Moving forward, FLBL’s returns are dependent on many factors, but interest rates are key. At current rates, the fund should return around 7.0% – 8.5% annually, considering its dividend yield and a slow, steady drip of defaults. ZIRP would mean yields in the 3.0% – 3.5% range, returns in the 2.0% – 3.5% range, broadly in-line with long-term returns. Smaller rate cuts would have a commensurately lower impact on fund returns. Although the figures above are accurate, I feel they might give readers an incorrect impression of the consistency of the fund’s returns and outperformance. There have been periods of long-lasting senior loan underperformance, with FLBL underperforming since inception in 2018 to 2022, for instance. Rates went down during said time period, hence the fund’s underperformance. Data by YChartsSpreads to high-yield bonds were negative at the time, which also weighed on the fund’s returns. These are much higher now, which should boost returns moving forward.Data by YChartsFinally, FLBL seems to have slightly outperformed its senior loan peer average, but not significantly or consistently so. Two other ETFs have marginally outperformed FLBL, but the difference does not seem all that material to me. Data by YCharts Conclusion FLBL is a simple actively managed senior loan ETF. In my opinion, its strong 8.3% dividend yield makes the fund a buy, while its comparatively low 0.45% expense ratio makes it a slightly superior investment opportunity than its senior loan peers.
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